The news coming out of Lloyds Banking Group (LSE: LLOY) and Barclays (LSE: BARC) could hardly have been more different over the past months. Lloyds’ return to dividend payments and the sale of the government’s final stake has made Lloyds an investors’ darling, while management turnover and further job cuts at Barclays have sent investors running for the exits.
However, investor reaction to the tumult at Barclays may be overdone as the company remains profitable, dividend payouts are increasing, and new CEO Jes Staley looks set to continue cutting back the cost-inefficient investment bank in favour of more profitable divisions. For the first nine months of 2015 Barclaycard, the company’s credit card business, provided roughly as much post-tax profit as the investment bank but with 40% lower revenue. Barclays’ strong retail banking operations also contribute nearly twice as much to overall profit as the investment bank while requiring much lower capital reserves and being lower risk. Given all of this, the recently-announced cuts to Asian investment banking operations make considerable sense as the company refocuses a slimmed-down IB arm on the more profitable US market.
Despite fears that Staley’s IB background would see a return to pre-eminence of those divisions, he looks set to continue paring back non-core businesses and focusing on the more profitable retail and Barclaycard divisions. With return on equity increasing 12% over the past nine months to reach 7.1%, there remains much work to do to reach the 2017 target of 12%. However, continuing on the current path provides a reasonable framework to reach that target. Shares are currently trading at a mere seven times 2016 earnings and will yield 3.6%, leading me to believe Barclays has significant upside for long-term growth investors as the company refocuses on high-margin, low-risk core businesses.
Reaping the rewards
While Barclays is still in the midst of major restructuring, Lloyds is far ahead and now looks set to reap the rewards after years of pain. Lloyds’ focus on retail banking and mortgage lending, of which it controls 20% of the market, makes it a strong play on the health of the domestic economy. After spending a staggering £13.9bn settling PPI claims, there’s light at the end of the tunnel for Lloyds as there’s growing talk of an end date to claims coming as early as 2018. The possible end to PPI payouts and passing the BoE’s latest stress test with flying colours mean that Lloyds is finally returning cash to shareholders.
Dividend yields are currently 3.3%, but are forecast to reach a very attractive 5.1% for 2016. A very strong return on equity of 15.7% means dividends should grow steadily for the foreseeable future as management returns cash to shareholders. As the UK economy grows slowly-but-steadily, there’s little potential for runaway growth in Lloyds’ share prices, but a steady return via dividends will attract income investors searching for a safe haven in turbulent markets. With shares trading at 8.2 times 2016 forecast earnings, I believe this spring’s government share offer provides an ideal opportunity to begin or expand a position in Lloyds.