Shares in Lloyds (LSE: LLOY) (NYSE: LYG.US) have more than tripled since the end of 2011. Investors who bet on the bank returning to normality without bad debts, the eurozone or some other calamity disrupting its recovery have been rightly rewarded.
Now it’s different
That was then. The investment case is different now. Lloyds’ turnaround is nearing completion — at least in the eyes of the future-discounting mechanism that is the stock market.
Lloyds is now a play on growth in the UK. As a high-street bank focused predominantly on retail and commercial banking, its fate will be to track the health of the UK economy.
Flourishing
With timing that CEO António Horta-Osório could only have dreamed about when he took on the job, the UK economy is flourishing just as Lloyds emerges, Phoenix-like from the ashes of its self-inflicted near-destruction. The factors pushing the shares upwards are:
- An economy that could hit a growth rate of 3%-4% this year, amongst the strongest in the developed world. Banks’ profits are closely linked with economic health through volumes of borrowing and deposits, levels of default, and general confidence;
- A buoyant housing market, explicitly encouraged by the Government. Whatever the fears about the creation of an asset bubble, the stimulus will continue up to next year’s general election;
- Momentum from further privatisation and the resumption of dividend payments.
It’s likely the Government will sell more of its one-third stake in Lloyds after the lender publishes its results in March — conveniently when Vodafone shareholders will receive their cash receipts. A retail tranche could see a scramble like the Royal Mail privatisation, though there will already be an established market price.
Expensive
That price is now quite punchy: at 1.5 times tangible book value, Lloyds is the most expensive UK bank. But while the broker upgrades that drove the share price up during 2012 have tailed off, the economy could help the bank surprise on the upside.
Lloyds plans eventually to distribute 70% of its earnings. That will put it firmly in income stock territory — but it underlines the limits to its growth. There are some headwinds down the road: the UK economy is boosting Lloyds now, but in future it will be a constraint. The disposal of Lloyds’ TBS business, and RBS‘s sale of William & Glyn’s, will create a more competitive banking landscape than the pre-crisis Lloyds enjoyed.
Lloyds’ shareholders have seen the best of the recovery, but the bank has good prospects as a long-term income stock.