There were no Barclays-style banana skins for Lloyds Banking Group, yet the country’s largest mortgage lender still can’t catch a break with investors.
Lloyds’ shares have been priced at a 26 per cent discount to their forecast tangible book value in 12 months’ time. True, that’s narrower than a yawning 61 per cent gap for Barclays and a touch better than the 32 per cent discount embedded in NatWest’s share price — but then Lloyds deserves to trade at a relative premium to its British peers.
Its third-quarter numbers did not disappoint. Adjusted pre-tax profits were up 22 per cent year-on-year to just over £2 billion, mainly thanks to much lower impairment charges. Only £187 million was set aside for potential bad debts, down from £668 million in the third quarter of last year.
The British-focused “black horse” bank has set out more optimistic economic forecasts, too, modelling higher GDP growth and a smaller rise in unemployment. It now assumes that interest rates will peak at the present 5.25 per cent rate, rather than 5.5 per cent. Impairments this year had been expected to represent about 30 basis points of total lending balances, but are now set to be below that level. A return on tangible equity of 16.6 per cent this year easily puts it on track to hit its annual target to surpass 14 per cent. That means returns are at least equal to the bank’s cost of capital.
Shareholders should be able to look forward to a better dividend and extra returns on top when Lloyds announces full-year results in February. The common equity tier one ratio stands at 14.6 per cent, well above an internal 13.5 per cent target.
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The deficit across its three defined-benefit pension schemes has shrunk to only £250 million, a significant reduction from a funding gap of more than £7 billion at the time of the last triennial valuation in 2019.
Analysts have forecast an ordinary dividend of 2.77p this year. Special returns seem likely to take the form of share buybacks, given the paltry price. Analysts at Shore Capital think the bank will announce share purchases of at least £2 billion.
Nevertheless, the discount applied to Lloyds’ shares remains stubborn. Reservations about whether Britain could enter a recession are a clear obstacle to closing that gap. Lloyds is a bellwether for the domestic economy. There is also a recognition that the easy boost from rising interest rates won’t last. After a slower start, banks are starting to pay more on customer deposits. Consumers are also shifting more of their money from current to savings accounts that offer higher rates. Greater competition in the market similarly means that the margins on mortgages are being squeezed.
Forecasts for a net interest margin of above 3.1 per cent for the whole year has been kept. That margin, the difference between what a lender generates on loans and pays customers on deposits, declined to 3.08 per cent in the third quarter. That implies a fourth-quarter exit rate of about 3 per cent, reckons RBC Capital, below the consensus forecast of 3.09 per cent for next year.
A fall in net interest margins across the industry is inevitable as deposit rates move closer towards lending rates, but better branch and digital banking services mean Lloyds should be less sensitive to customers shifting their money out of current accounts for a longer period, RBC Capital thinks. That could limit the impact on its funding costs.
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A lower average loan-to-value ratio on its back book of mortgages and a better cost-to-income ratio are other relative attractions for Lloyds. If Lloyds’ sunnier economic outlook proves well-founded, there’s the chance the shares could start to make headway in closing the discount.
ADVICE Buy
WHY The shares look too cheap, given benign impairments and chance of higher cash returns
Reckitt Benckiser
There’s no quick fix for Reckitt Benckiser. In his first update to the market Kris Licht, the new boss of the consumer goods group, has unveiled a £1 billion share buyback programme over the next 12 months, but investors are more interested in how he plans to resuscitate sluggish sales growth.
Like-for-like sales growth disappointed again in the third quarter, with a 3.4 per cent increase missing a 3.7 per cent consensus forecast. Nutrition, which is lapping a period when Abbott, its chief rival, came out of the American infant formula market, continues to be the main drag.
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Licht, 47, is hardly ripping up the strategy pursued by Laxman Narasimhan, his predecessor. A review of its portfolio is under way, but Licht won’t say exactly which, if any, of Reckitt’s brands will be for the chop. There are also vague plans to cut fixed costs, mainly in back-office functions such as HR and legal. Licht has said he would not rule out job cuts.
The biggest departure is a prudent move to drop a margin target in the mid-twenties by the mid-2020s. Instead, the new boss has stuck with a looser goal to grow adjusted operating profit ahead of net revenue. That should give the group the flexibility to throw more cash behind both research and development and marketing. The latter has lagged peers as a proportion of revenue and playing catch-up could help to push the top line forward faster.
Tangible signs of progress are needed to win over the market. The shares have already been priced for lower growth. A forward earnings ratio of 16 is near the decade low and is a discount to both domestic and international competitors.
A return to growth in that nutrition business also might instil more confidence. The impact may take another three quarters to unwind, according to Licht. Reckitt began raising prices at the start of the year, but Abbott did not, so the return to volume growth in the nutrition business will depend, too, on the pace at which Reckitt’s rival starts to lift its prices.
The inflation sugar boost is fading and it will start to become more obvious where genuine demand lies.
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ADVICE Hold
WHY Dropping a firm margin target might help to spur better sales growth
