Investors need convincing reasons to look through a shaky economic backdrop and a mini-banking crisis. Lloyds Banking Group, therefore, will have to work harder to prove it deserves a higher valuation from the market.
True, first-quarter impairments for potential bad debts were less severe than expected at £243 million and income generated from non-lending sources was also higher. The upshot? Pre-tax profits were better than expected, up 46 per cent to £2.26 billion.
But if investors were betting on better first-quarter figures to result in upgrades for the full year, they were disappointed. Guidance for the closely watched net interest margin — the difference between the rates paid on deposits and those charged on loans — is stuck at “greater than” 3.05 per cent for this year, despite the base rate rising to 4.25 per cent, beyond the 4 per cent Lloyds had assumed. Analysts at Jefferies saw scope for guidance to be lifted to 3.1 per cent, given higher swap rates and the base rate rise.
Rising competition on both sides of the margin is to blame. Rates have started to come down in the mortgage market and to rise on customer deposits, an importantly cheaper source of funding. More customers switching, as well as being forced to spend their savings to cope with the higher cost of living, meant Lloyds’ deposit levels dipped slightly on quarterly and annual bases.
That’s not the only reason investors might think twice about Lloyds’ potential to sustain its income growth this year. The higher cost of funding its non-lending activities, which would include its wealth management and private rental housing interests, took a bite out of Lloyds’ net interest income. More importantly, it was a blind spot — very little of the £300 million in funding costs was accounted for in consensus figures.
Why does that matter so much? RBC Capital’s thesis was that if Lloyds can keep pushing up diverse sources of income, then it might be able to maintain momentum in its top line once the benefit of interest rate rises fades. That might need a rethink, depending on the extent the cost of funding those other business lines eats into net interest income.
A share price decline of 3.6 per cent yesterday takes total losses to 13 per cent since the end of February. Banking crises in the United States and Switzerland have increased the shares’ discount versus the tangible book value forecast for the end of December, which now stands at almost 14 per cent. That’s still far better than laggards like Barclays and Standard Chartered and justifiably so.
Lloyds’ liquidity coverage ratio, a measure of the proportion of deposits kept in cash by banks to meet surges in withdrawal volumes, stood at 143 per cent. The common equity tier one ratio was 14.1 per cent, above an internal target of 13.5 per cent. That means investors should feel confident enough in another bump-up in the dividend this year, with special returns to boot.
The 175 basis points in capital generation suggested equates to £3.5 billion. There’s also £1.5 billion in excess capital held by the bank, which the company intends to reduce by the end of next year. Split the latter into two and it leaves £4.25 billion in capital to play with this year, enough to fund an increase in last year’s £3.6 billion shareholder returns. Analysts’ consensus is for an ordinary dividend of 2.74p a share, which would leave the shares offering a beefy potential yield of almost 6 per cent at the current price.
Lloyds should be in line for a £7.2 billion pre-tax profit this year, if forecasts are right, up on £4.8 billion last year. Progress is expected to be much slower from there. If interest rates are reaching their peak, there is more onus on Lloyds’ side-bets to start proving their worth.
ADVICE Hold
WHY The shares may be lacking impetus if interest rates are nearing their peak
Wickes
Disappointing trading figures from larger rivals and last year’s profit warning have set a low bar for Wickes to surpass.
Like-for-like sales at the DIY retail chain fell by 0.6 per cent over the first 16 weeks of the financial year, pushed lower by weaker demand from both consumers and trade customers. Yet the shares rose by a little under 2 per cent. What might investors be clinging on to? A healthier showing from the fitted kitchen and bathroom business, where sales were just over 9 per cent ahead over the same period last year.
True, that business has a higher margin, but it also accounts for only about a quarter of group sales. The retailer has been working through an elevated order book, so what happens when that runs down? Orders in the first 16 weeks of the year were up marginally year-on-year. And challenges remain for the core business as the housing market falters and cost of living pressures sap broader consumer spending.
Earnings expectations might be a way below where they were when the group joined the London market in 2021, but optimism has improved since a September trough. The shares trade at eight times forward earnings, bang in line with the historic average. Does that really represent value?
Analysts at Peel Hunt forecast a 2.3 per cent decline in underlying sales this year, split roughly as a 7 per cent increase in prices offset by a 9 per cent fall in volumes. That should translate to adjusted pre-tax profits of £57 million this year, down from £75.4 million last year, the broker reckons, before staying broadly flat next year.
Cost inflation, at least, has eased, to 10 per cent during the second half of last year and now down again to single-digit levels. There is also the chance of a generous dividend being paid to shareholders, given that the company had almost £100 million in net cash on the balance sheet at last count.
Peel Hunt has forecast an ordinary dividend of 6.9p a share, which equates to a potential yield of roughly 4.9 per cent at the current share price. But in a time of depressed equity markets, that is no great shakes.
ADVICE Avoid
WHY Cost of living pressures and a shakier housing market may hit sales
