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TEMPUS

Still waiting for a rate-rise uplift

The Times

This isn’t the moment in the sun that lenders had been longing for, now that the worst potential economic consequences of the pandemic have been averted and rate rises are finally materialising.

Shares in Lloyds Banking Group, the UK’s largest mortgage lender, have been in purgatory since the middle of last year, bound from moving higher by fears of an economic slowdown, which could cause a rise in bad debts and choke the housing market.

In the tug-of-war between those concerns and the benefit of higher rates, the former is winning out, with Lloyds shares still trading at a 17 per cent discount to tangible net assets at the end of last month.

First-quarter figures should allay concerns. The lender has increased guidance for the banking net interest margin this year to at least 2.7 per cent, from the 2.6 per cent expected at the end of last year, and expects the return on tangible equity to be about 1 percentage point better too, at 11 per cent.

Aside from making more money on new loans, Lloyds also benefits from a large deposit base, which when the full benefit of a rising base rate isn’t being fully passed through to savers, provides a cheap source of funding.

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Impairments for toxic loans are fairly benign, at £177 million for the first quarter, which while worse than the net release of cash set aside this time last year, is still below pre-pandemic norms. The bank’s inflation expectations are higher than they were three months ago, which prompted the lender to set aside an extra £100 million “overlay”, cash to account for any nasties that might cause a deterioration in repayment levels.

Then there is the risk of further charges to compensate victims of historic fraud at HBOS Reading. So far, £790 million has been set aside and no further provisions were made during the first quarter, but management has acknowledged that “significant uncertainties remain”.

Lloyds is also betting on unemployment remaining low, and actually more so than it did at the end of last year, which, if accurate, means borrowers should still be able to meet repayments despite the higher cost of living. Lloyds’ typically wealthier customer demographic stands to be better insulated from such pressures, reckons the Shore Capital analyst Gary Greenwood. The risk is that inflation batters companies so much that they lay-off more staff and joblessness rises.

The banking group’s high share of the mortgage market means it is more exposed to a slowdown in the housing market. Mortgage rates are rising, but still historically cheap. The problem is more around confidence in wannabe homebuyers being sapped by higher living costs. The mortgage market is still intensely competitive, as banks flush with deposits seek to put cash to work.

Lloyds’ own cost base remains in check, with expenses relating to the day-to-day running of the business flat and guidance reiterated for a full-year figure of £8.8 billion, after taking into account the cash it is throwing behind new products.

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The banking group has a record of keeping a tighter rein on costs than peers, keeping the cost to income ratio in the mid-50s even amid last year’s rise in remediation costs and the fall in new lending and interest rates as the pandemic took hold the year before. That’s better than ratios reported by NatWest, in the mid-70s, and Barclays, north of 60.

Having a handle on costs and the boost from rising interest rates have benefited capital generation, which bodes well for the dividend. That payment is forecast to rise to 2.31p a share this year, a potential yield of 5 per cent at the current share price. That’s good enough for income investors but the uncertainty around markets could maintain a iron grip on the shares in the near-term.

ADVICE Hold
WHY Slowing economic growth could cause the shares to tread water

Ceres Power
Rapidly rising inflation means investors aren’t in the mood to back speculative high growth stories, which explains an almost 60 per cent decline in the shares of Aim darling Ceres Power since the start of last year. Not that the fall from grace means investors will get the shares on the cheap — the fuel cell specialist’s enterprise value still represents an eye-watering multiple of 29 times forecast sales.

Ceres designs fuel-cell technology under licence for its commercial partners, for which it receives a fee. It then earns royalties based upon the volume of product manufactured by those companies. Those royalties flow through almost entirely to the bottom line, which means gross margins are close to 70 per cent.

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Ceres has some big-name manufacturing partners embedding its technology into their products: Bosch, the German technology group, Weichai, the Chinese engine manufacturer, and Doosan, the South Korean heavy equipment maker. That has helped propel impressive revenue growth, which thanks to licence fee income from the latter last year, was 44 per cent higher than the year before.

The fuel cell side of the business is more mature, and close towards profitability. Adjusted losses halved to £4.5 million last year. But its green hydrogen business, which attempts to develop the technology to clean-up industries that have traditionally been hard to decarbonise, such as shipping, is in a stage of heavy investment, raising £179 million last year to fund the development of the electrolysis technology.

What that boils down to is no expectation of a statutory profit being turned any time soon, which analysts at Liberum reckon won’t arrive before 2025. The brokerage has forecast a loss before taxes and other charges of £15.7 million this year, rising to £17.7 million by 2024.

The addressable market for Ceres’s technology is vast, particularly as issues of energy security are brought to the fore. The US is a market of particular interest, stoked by the arrival of the Biden administration and renewed interest in clean energy. However, the turning of the tide away from growth stocks is a strong force to swim against.

ADVICE Hold
WHY Toppy valuation will likely prevent the shares re-rating anytime soon

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