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Lloyds Stock Is a Post-Brexit ‘Pure U.K. Banking Play’

Kanene

Feb. 13, 2020

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Investors looking to bet on a Brexit-fueled jump in Britain’s economy should consider buying shares in United Kingdom–based financial powerhouse Lloyds Banking Group .
The stock is cheap and highly geared to the U.K. economy, and you’ll also get paid a hefty dividend while you wait.
Lloyds (ticker: LYG) is “our preferred U.K. bank stock,” Barclays, which rates the company Outperform, wrote in a recent report. “We see significant variation in capital return across U.K. banks, with Lloyds offering the strongest prospects.”
Barclays says the stock is worth 32% more than its recent price in British pounds. Plus, investors can add a projected cash dividend of about 6%, and there’s the potential for a rally in the value of the British pound sterling, which took a hit after the Brexit referendum in 2016. The company’s American depositary receipts have lost 1% in the past 12 months and are down 11.8% this year.
Barclays’ bullish view isn’t unique. The stock is the top large-cap U.K. banking pick for RBC Capital Markets, which rates Lloyds Outperform. RBC rated U.K. banking competitors HSBC Holdings (HSBC), Royal Bank of Scotland Group (RBS), and Barclays (BCS) lower than Lloyds.
The reasons to buy Lloyds, which has a market cap of 40 billion pounds sterling ($52 billion), go deeper than just broker ratings. The stock’s prospects and those of Britain will likely move in lockstep with loan profits increasing as the economy expands.
“Lloyds is a pure U.K. banking play,” according to Morningstar. It notes that 95% of the company’s assets are located in Britain. While the Lloyds corporate name refers to the eponymous retail bank chain, the company owns a slew of major Main Street brands, including the Bank of Scotland and Halifax, as well as Scottish Widows, an insurance and asset-management company.
Heavy U.K. exposure is a good thing now. Although the British economy saw zero growth in the fourth quarter, forward-looking data are far more bullish. “Sluggish growth is old news,” according to a recent report from London-based TS Lombard. The IHS Markit/CIPS U.K. Composite PMI, which tracks whether the economy is expanding or contracting, had a bumper 53.3 reading in January, its best since September 2018. Readings above 50 indicate expansion.
Economic growth is likely to get a helping hand from increased government spending. The recently re-elected Prime Minister Boris Johnson has promised to send development cash to poorer areas of the country and to start significant infrastructure projects. “To the extent that it jump-starts growth, that will be good for the banks,” says Konstantinos Venetis, a senior economist at TS Lombard.
The stock’s value is cheap relative to its history and when compared with the broader U.K. or U.S. markets. Shares were recently trading at 8.1 times forward earnings, far lower than the five-year average of 13.2 times. The MSCI United Kingdom index, which tracks a basket of U.K. stocks, trades at a forward price/earnings ratio of 13.3. The MSCI USA index, which follows U.S. stocks, trades at 19.9 times next year’s earnings, according to Yardeni Research.
Lloyds looks set to show better operating performance than its peers this year. According to RBC, this year Lloyds will probably generate a return on tangible equity of 13.9%, versus 8.8% to 10.5% for Barclays, RBS, and HSBC.
There are risks to buying Lloyds. If Britain’s economy slumps, Lloyds will probably get hit hard. “Banks and growth is a two-way street,” says Lombard’s Venetis. The strength of the U.K. economy also depends on securing a renewed trade deal with the European Union before next year. “If Brexit goes wrong, you get capital leaving the U.K.,” he says.
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