With the Lloyds share price dipping beneath 100p after reaching the heady heights of 112p early this year, are they starting to look cheap?
One would look back to where they were a couple of years ago and think not. But a lot has happened since then, and sentiment towards FTSE 100 banks has improved dramatically.
In many respects, the doubling of Lloyds from 50p – where it spent nearly 3 years – brought the company back to where it should be, rather than pushing it into ‘overvalued’ territory.
Lloyds and many other banks were trading at around 50% of their book value for years. Lloyds now trades at 1.2x book. This is a fair valuation for a bank of its size and reflects the quality of its asset base.
But it’s the earnings outlook that will drive the price higher from this point forward, with the motor scandal behind them and the group on a firm footing.
Lloyds delivered a confident first quarter, with statutory profit before tax up 33% to £2.0bn and a return on tangible equity of 17.0%. But beneath the headline strength sit several pressures that could yet weigh on the share price, particularly if the UK economy turns.
There was a warning sign from impairments – a whisper of a warning, but a warning nonetheless. The underlying charge of £295m was lower than a year ago, but it masks a £101m hit from updated economic scenarios, with £151m reflecting a darker outlook tied to the Middle East conflict. That was only partly cushioned by releasing a £50m buffer previously held against tariff and political risk. These provisions were made in the earlier stages of the war, and after a prolonged period of higher fuel costs, there may well be more in Q2.
Margins are the second concern. The banking net interest margin of 3.17% looks healthy and is being propped up by the structural hedge, which is now expected to generate £7bn-plus this year. But Lloyds openly flags asset margin compression, “in particular in the UK mortgages portfolio”. If hedge tailwinds fade or rates move against them, that support could diminish.
Its fortunes are tightly bound to UK mortgages, UK consumers, and UK businesses. With the economic outlook deteriorating enough to force a higher provisioning charge this quarter, any further weakness in employment or house prices would hit Lloyds harder than most.
The question is how bad the UK economy will get later this year if inflation rises to 4%, as some economists predict.
Trading at a 9.8x forecast earnings multiple, Lloyds shares are marginally undervalued relative to the benchmark and offer upside if the economy avoids a doomsday scenario.