We got an unpleasant surprise when Barclays told us it was going to slash its dividends for 2016 and 2017 to just 3p per share – yields were already modest at around 3%, and after the cut we’re looking at only around 1.3% for the year just ended, based on a share price of 231p.
We were later hit by the shock result of the Brexit referendum, which trashed the whole banking sector. But despite those two shocks, Barclays shares are actually up 22% over the past 12 months, and up 82% since the post-referendum crash.
Lloyds so cheap
Why then, are Lloyds Banking Group (LSE: LLOY) shares so lowly valued by comparison? Over the same 12 months, they’re down 2%, and at 65p they still haven’t regained their pre-referendum level.
Part of the reason is surely because analysts are expecting a couple of years of modestly falling earnings from Lloyds, while Barclays has growth pencilled-in for this year and next. But there must be fears of a dividend cut in the mix too.
The whole banking sector could come under increased cashflow pressure over the next couple of years as the shape of our Brexit becomes clearer — and it’s looking harder by the minute. Couple that with Lloyds’ forecast earnings per share for 2016, which are expected to cover the predicted dividend only around 1.5 times, and that fear doesn’t seem unreasonable.
No cut then?
But will a dividend cut really happen? I don’t think it will, for several reasons. For one, Lloyds isn’t facing anything close to the restructuring that Barclays is undergoing — Barclays is aiming to become “a simplified transatlantic, consumer, corporate and investment bank“, and it really needs to retain its cash to pay for it.
Lloyds, meanwhile, maintains a “simple and low-risk, UK-focused, retail and commercial business model“. That’s strongly cash generative, and won’t place anything like the same demands on capital expenditure as we’re seeing at Barclays.
On top of that, Lloyds is in a strong capital position, and sailed through the Bank of England’s most recent stress tests, the results of which were released in November. Despite the tests coming at a time of more severe economic stress, Lloyds told us it “comfortably exceeds the higher capital and leverage thresholds set out for the purpose of the stress test“.
In the most arduous part of the test, the bank’s liquidity ratios remained nicely ahead of the BoE’s minimum requirements, with a low-point CET1 ratio that was better than 2015’s result — Lloyds put that down to the de-risking it has undertaken.
Buy or sell?
So what does that mean for investors? Well, we’re pretty much certain to see another year or two of major uncertainty in the banking sector, especially with Brexit negotiations expected to get under way any time now, and uncertainty is the thing that institutional investors fear the most.
All told, I reckon that probably means we’ll see depressed share prices continuing for some time in the banking sector.
But that, in my view, presents a nice opportunity for patient private investors to grab a bargain. We’re looking at a forward P/E of under 10 here, and that makes Lloyds shares look like a long-term buy to me.