When American GIs were castigated by the British population as “over-paid, over-sexed and over here” during the Second World War, the antipathy of the British population was tinged with admiration. I have similar mixed feelings towards Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US).
Its turnaround has been remarkably successful, with the benefits of self-help restructuring amplified by the unexpectedly strong recovery in the UK economy. But Lloyds is very much ‘over here’: following a Dunkirk-like retreat from Europe, it is now almost entirely dependent on the UK. Arguably, it is also over-exposed — especially to the housing market — and its stock is over-priced.
Over-exposed
Reliance on the UK economy makes the shares vulnerable. Expectations that the Britain will continue to thrive are baked in. It may be a reasonable central projection, but there’s plenty of downside risk. I think it’s significant that three component distributors, Electrocomponents, Premier Farnell and Brammer, all issued profit warnings this month, citing weak UK sales and/or intensified competition. These suppliers of bits and bobs for industry are a bellwether for that sector.
The housing market is supported by artificially low interest rates. It looks as though Bank of England Governor Mark Carney has no intention of raising rates soon, fearing deflation and no doubt reluctant to upset the apple-cart before next May’s general election, but he can’t hold them down indefinitely. The national debt is larger than ever, as is the trade deficit, and the pound has lost a fifth of its value since 2008. Per-capita GDP is still below pre-financial crisis levels, and the Central Bank is cutting its growth forecasts.
The approaching General Election adds uncertainty. If the economy wobbles before May that could make a Labour victory look more likely. Some might see David Cameron’s “red warning lights on the dashboard of the global economy” as preparing the electorate for poorer-than-expected economic news. Rising anticipation of a Labour victory would be bad for stocks like Lloyds: Labour leader Ed Miliband has talked of breaking up the high-street banks.
Lloyds faces some specific challenges, too. It has built up expectations of a return to the dividend list, but its performance under the ECB’s capital stress test has potentially jeopardised that. A Competition Commission review of the market for current accounts doesn’t help, either.
Over-priced
These downside risks wouldn’t be so dangerous if the shares were more reasonably priced. Lloyds’ forward PE is broadly in line with the rest of the sector, but in these days where banks report half-a-dozen or more profit figures, investors have paid more attention to price:book ratios. On that basis, Lloyds’ 1.4 price:book is significantly more expensive than its peers, highlighting how much anticipation of future growth is built into the share price.
So for me, Lloyds is a share that has many attractions, but not right now, at this price.