Investors in Lloyds Banking Group shares (LON:LLOY) have had little reason to cheer in the past year.
The pandemic, low interest rates and weak consumer confidence have stifled Lloyds Bank’s investment appeal. As such, its shares continue to trade around 15% below their pre-coronavirus price level.
However, the bank’s fortunes could be about to change. The UK’s economic performance is widely forecast to drastically improve as lockdown measures abate. For instance, the IMF expects UK GDP growth to be in excess of 5% in 2021 and in 2022. This could lead to increased consumer activity, in terms of higher demand for mortgages, loans and other services.
Their take-up may be further lifted by the release of pent-up demand resulting from record UK consumer savings amassed during recent lockdowns. Encouragingly, the GfK Consumer Confidence index has risen from minus 33 in November 2020 to minus 15 in April 2021. This is similar to the level recorded in the final quarter of 2019 and suggests that consumer spending could rise in the coming months.
A solid position
Lloyds appears to be in a strong position to capitalise on an improving economic and consumer outlook. Its financial position has improved over recent years. It now has a Common Equity Tier 1 (CET1) ratio of 16.7% versus a regulatory requirement of 11%.
It also plans to further reduce operating costs to £7.5bn in the current year, while investing in digital growth opportunities in response to changing consumer tastes. Its size and scale may provide an advantage over challenger peers in the online space.
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An improving economic outlook may be a prelude to the return of dividends across the banking sector in 2021. Indeed, Lloyds is expected to pay dividends of 1.9p per share this year. This equates to a forward dividend yield of 4%. Shareholder payouts could increase over the long run as a result of the bank’s modest forecast dividend payout ratio of 34% for 2021.
Meanwhile, Lloyds has a relatively undemanding valuation despite its improving outlook. For example, it trades 10% below its tangible book value and has a forward price-earnings ratio of 8.5.
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An attractive risk/reward opportunity
Of course, low interest rates are likely to act as a drag on Lloyds’ net income over the next few years. The bank’s net interest margin was just 249 basis points in the first quarter of the year, which is a 30 basis point year-on-year decline. The Bank of England is not expected to raise interest rates either this year or next year due to below target inflation prospects. This may limit profit growth across the sector, as well as curb investor enthusiasm towards Lloyds.
Moreover, a UK economic recovery is not guaranteed. Threats such as a new variant of Covid-19 that prompts renewed lockdown measures could negatively impact on the UK’s economic prospects. Meanwhile, the bank recently welcomed a new CEO. This could prompt a strategy change and increased caution among investors.
However, Lloyds’ low share price valuation appears to include a margin of safety to account for such threats. Furthermore, its solid financial position, improving earnings prospects catalysed by an economic recovery and income potential suggest that it has an attractive risk/reward profile.