I reckon Lloyds (LSE: LLOY) could be an excellent way to invest in the UK economic recovery. With that in mind, I’ve been reviewing the banking business to see it could be worth investing a modest proportion of my portfolio in the stock.
Improving fundamentals
Over the past few months, it’s become clear to me the market doesn’t appreciate the recent improvement in Lloyds’ outlook. Since the end of 2020, the bank’s outlook has improved markedly. However, the Lloyds share price has failed to reflect this, in my opinion.
For example, according to its first-quarter earnings report, its income hit £3.7bn in the three months to the end of March. That was down about 7% year-on-year, which is impressive, considering the economic environment. During the first quarter of 2021, the UK economy was under one of the strictest lockdowns in the world.
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Despite the lockdowns, the bank released £323m of provisions for bad debts. Management had expected borrowers to default on these loans, but that seems no longer to be the case. The release reflects the UK’s improved economic outlook. There’s still around £1bn held back to offset coronavirus losses.
And as profits have improved, the lender’s balance sheet has strengthened. The bank reported a Common Equity Tier 1 Ratio (a key measure of banking capital) of 16.7%, up from 16.2% at the end of December. That figure’s pretty high.
At the end of 2020, the average ratio of European banks regulated by the European Central Bank was 15.6%. To put it another way, Lloyds’ balance sheet is stronger than average.
I think that bodes well for the group’s dividend potential. Management has said it will issue further guidance on dividends alongside its half-year results.
Lloyds share price struggles
All of the above suggests to me Lloyds has weathered the coronavirus crisis incredibly well. As such, I think the stock is undervalued at current levels. The group earned £3.7bn in the first quarter of 2021, £3.9bn in 2020, and £4.4bn in 2019.
Overall, net income has declined 16% from the highs of 2019. However, the Lloyds share price has fallen 26% from those related highs.
These figures suggest to me the stock has yet to reflect the bank’s progress. That’s why I believe the shares are undervalued and why I’d add the stock to my portfolio today.
That said, there are some risks the bank may face as we advance. These include low interest rates, which are already playing havoc with the lender’s profit margins. If rates fall further, it’ll become harder for Lloyds to earn a profit. Another wave of coronavirus may also damager the group’s balance sheet if loan losses rise.
Still, even after taking these challenges and risks into account, I think the future’s bright for the Lloyds share price. I think it could be one of the biggest beneficiaries of the UK economic recovery currently taking place.
