What now for Lloyds as retail share offer withdrawn

In early October, while on a trip to the USA, Chancellor of the Exchequer Philip Hammond announced that the Government would again try to sell its final 9% stake in the Lloyds Banking Group. This immediately drove the shares down 4% and left private investors with a dilemma, as Hammond made it clear they would not be given chance to participate in the deal.

This is all a marked contrast to what had been planned. In 2015, as part of the Conservative Party manifesto, former Chancellor of the Exchequer George Osborne, declared he wanted to involve retail investors in the final disposal of the Government’s remaining holding in Lloyds, in the manner of the big 1980s privatisations – complete with discount prices and incentives for holding on to the shares.

That has all gone. Mr. Osborne’s replacement, Philip Hammond, remains keen to sell the remaining shares held by UK Financial Investments but he is going to offer them to institutional investors only. US investment bank Morgan Stanley has been appointed to sell the shares in a number of chunks, possibly by the end of the year.

This will be particularly relevant to those of you who registered your initial interest in the share sale with AJ Bell. 

You may still end up with some more Lloyds shares in your company pension fund if you have one, but the only way you can buy some directly is to do so in the open market via your own SIPP, ISA or dealing account.

Whether you feel the bank is appropriate for your portfolio is something only you can decide – and you will need to do your research before you decide whether Lloyds fits with your own personal investment strategy, time horizon, target returns and appetite for risk.

Change of plan

When George Osborne postponed the proposed sale of the Government’s final 9% stake in Lloyds back in February, he blamed market volatility – stocks had wobbled globally following the US Federal Reserve’s first interest rate hike in the thick end of a decade in December.
Lloyds’ shares had slipped to 65p, well below the Government’s average purchase price of almost 74p apiece.

New Chancellor Philip Hammond has blamed the same problem his decision to go ahead without giving private investors a chance to get involved – volatility.

At first sight this seems odd, given the FTSE 100 is trading at around the 7,000 level and bearing down on a new all-time high:

FTSE 100 is trading at around the 7,000 level and bearing down on a new all-time high
Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

But from another perspective it does make sense. Lloyds shares are lower now than they were back in February and sentiment towards the banks sector worldwide remains downbeat. 

Lloyds shares are lower now than they were back in February and sentiment towards the banks sector worldwide remains downbeat.
Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

Banking stock indices in the UK, Europe and USA have rallied a little over the summer but renewed concerns – as yet unproven – over the financial health of European giants Deutsche Bank and Credit Suisse and a misconduct scandal involving America’s Wells Fargo are casting a cloud. Analysts also remain concerned about the impact of negative or record-low interest rates on banks’ profitability.

Lloyds shares are lower now than they were back in February and sentiment towards the banks sector worldwide remains downbeat.
Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

New deal

Nevertheless, Chancellor Hammond is keen to liquidate the Government’s remaining 9% stake in Lloyds, which is worth around £3.3 billion on a 52p share price. There may be three reasons for this

First, the Government has already recouped some £17 billion of its initial £20 billion outlay on Lloyds, so it will be able to get all of its money back if it can raise about £3 billion by selling this final block of stock.

Second, this cash could enable the Government to pay down its debts

Third, this could in turn provide Hammond and Prime Minister Theresa May with a little wiggle room when it comes to the November Autumn Statement and next Spring’s Budget, when it is thought they will look to move away from the Cameron-Osborne austerity narrative and perhaps look to infrastructure spending and fiscal stimulus to give the economy a boost.

Dividend dynamic

Lloyds’ shares didn’t take too kindly to the news that a sale was back on, especially one that may be done in bite-size chunks, and they fell 4% on the day of the announcement.

This now means investors who registered interest in the shares must decide whether to get involved in the open market or not, so let’s weigh up the investment case. 

Lloyds operates in a fairly mature market, that is very competitive and pretty tightly regulated, especially when it comes to how much capital the bank has to keep on its balance sheet to try and protect itself from any future downturns. All of these features mean earnings growth is likely to be modest.

That means the bulk of future returns may have to come from dividends and the yield on the stock. The good news here is Lloyds reinitiated dividend payments in 2014 at 0.75p a share and grew that to 2.25p 2015. 

The analyst consensus is for a 3.1p payment in 2016, enough for a 6.0% yield on the current share price of 52p.

Higher dividend payments and a juicy potential yield therefore probably form the key planks of the investment case for Lloyds.

But there are clear risks.

First, this chart shows how analysts have consistently cut their earnings forecasts for the bank all the way back to 2014. Each line looks at pre-tax income for a given year and shows the trend in analyst estimates by quarter -  and the trend is not hard to spot.

  Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16
Lloyds 2014 pre-tax profit (£ m) 6,681 6,723 1,762 1,762 1,762 1,762 1,762 1,762
Lloyds 2015 pre-tax profit (£ m) 7,511 7,478 7,848 8,182 8,162 1,644 1,644 1,644
Lloyds 2016E pre-tax profit (£ m)   7,819 8,102 8,064 7,923 5,424 7,782 6,762
Lloyds 2017E pre-tax profit (£ m)           5,524 7,738 6,455

Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

 

This has the knock-on effect of meaning dividend forecasts have shown a similar depressing trend:

  Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16
Lloyds 2014 dividend (pence) 1.06 0.75 0.75 0.75 0.75 0.75 0.75 0.75
Lloyds 2015 dividend (pence) 2.90 2.84 2.76 2.51 2.39 2.25 2.25 2.25
Lloyds 2016E dividend (pence)   4.12 4.24 3.87 3.70 4.12 4.38 3.18
Lloyds 2017E dividend (pence)           4.94 5.09 3.39

Source: Thomson Reuters Datastream
NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

This slide in estimates means there is always the danger Lloyds becomes a value trap – a stock that always looks cheap (in this case on dividend yield and perhaps book value) but one where the share price keeps falling as expectations are not met.

Price has to be right

Other factors to consider are whether Brexit, when it happens, has any impact on the UK economy, when and if the Bank of England will ever raise interest rates and what is going to happen to the UK’s currently bubbly housing market, where Lloyds is a major mortgage lender.

If the answers are nothing, not for a long time and nothing, Lloyds could rebound quickly.

If the answers are recession, quicker than the market thinks if inflation picks up and a downturn is coming, then the shares could still struggle.

Only you can decide which scenario develops – or whether something else happens – and at what level Lloyds shares represent value given any possible chain of events.

Russ Mould, AJ Bell Investment Director