Updated: Sep 22, 2020
"A bank stock that has been written off for over a decade, but they are taking the right steps to build long term value to those that are patient."
Historically, buying value stocks has helped Retail Investors improve performance over the long term. In fact one of the best investors of our time Warren Buffett has followed someone by the name of Benjamin Graham. Graham taught us the long term value investing strategy of purchasing stocks at a price below their intrinsic value; then holding them until their price reflects the real value of the company. Warren Buffet described Benjamin Graham’s book The Intelligent Investor as “by far the best book on investing ever written”.
It's been an incredible ride with many growth stocks over the last year and even decade for that matter. Growth stocks have rewarded investors but I am very much aware that its critically important to ensure I continue to invest in value stocks. It's important part of creating a blanced portfolio. Nobel Laureate Eugene Fama and researcher Kenneth French, former professors at the University of Chicago Booth School of Business have written that Investors with a long-term time horizon of 10-15 years or more will be rewarded for poor performance suffered in the short term. This is why I still look to financials as an area that could still hold potential long term gains to patient investors. I have bet with paypal and square along with many other fintechs, but I still believe that there are incredible bargains to be found in banks. One bank in particular that is on my radar is LLOYDS Banking Group, this could be a great stock to buy and hold over the long term.
Lloyds Banking Group (LYG)
Lloyds Banking Group (NYSE: LYG) is a UK based company providing banking and financial services, focused on personal and commercial customers. LLoyds provides retail, commercial and corporate banking, general insurance, and life, pensions and investment provision. LLoyds is basically the UK’s largest retail bank and mortgage lender with more than 2,000 branches and has a number of recognised brands including Lloyds Bank, Halifax and Bank of Scotland throughout the UK and £436 billion in assets.
Who owns Lloyds bank?
To ease concerns this bank is no longer owned by the government. Back in 2017 Lloyds reached a deal to sell its final shares. The government sold its remaining shares almost a decade after the £20.3bn bailout of the high street lender. This initially allowed the bank to finally start increasing dividends and repurchasing its shares, that is until COVID-19.
Why is the Lloyds share price so low?
There are a number of reasons why this banks stock price is down substantially over the past few years. Let's take a look at what has affected Lloyds stock:
Brexit, which has taken a toll on the bank because it's considered a pure play on the UK economy. With no one knowing what the ultimate outcome will be, investors are not sure how Brexit will affect the banks revenues and loans over the long term.
Late last year Lloyds planned to take billions of pounds in extra charges to cover a last-minute surge in claims relating to mis-sold payment protection insurance (PPI). This seems to never end and weigh on the stock but it will end at some point.
COVID-19. The pandemic has completely shut down the country and no one knows how badly damaged the economy will be long term. As a result Lloyds has suspended its dividend and share repurchases which has affected the stocks share price.
The U.K.'s Coronavirus Business Interruption Scheme, or CBILS, offers 80% state-guarantees on loans of up to £5 million for firms with a turnover below £45 million. But banks such as Lloyds are expected to cover 20% of the risk which is a concern to investors. Most countries such as the U.S. are providing 100% state-guaranteed loans.
The rise of financially savvy challenger banks and fintech companies, which can provide many of a bank’s functions but with a much lower cost basis. Fintech also do not have government bailout or brand issues and past bad behaviour that still plague major financial institutions today.
Let's see if now is a good time to buy Lloyds shares?
UK banks are in a much better place to weather a downturn than they were at the start of the 2008 financial crisis. Lloyds in fact has become in my opinion the envy of many banks both in the USA and Europe. Their efficiency ratio or cost-to-income (C:I) ratio is an incredible 48.5 percent. This ratio is an important metric in banking because it measures what lloyds operating cost base is compared to their operating income. The lower the percentage, the less they have to spend to generate income and at 48.5 percent, Lloyds shines since many banks are in the 60 percent range.
This may surprise you but Lloyds is considered the UK’s largest digital bank. They have been investing billions on transforming not only their technology systems but their processes as well. Basically getting rid of paper processes and people in favour of automation. More recently as part of a US$3.9 billion digital banking strategy, Lloyds is upgrading its multi-cloud approach with a new Google Cloud partnership. This move to cloud is showing Lloyds progressive approach to their digital transformation which will allow them to bring new services to their customers quickly and at scale.
"The new micro branches will be under 1,000 square feet and staffed by 1-2 people. Staff will be fully mobile, carriyng just tablet computers to help customers."
Apple store of banking
This appears to be the direction Lloyds is moving to, shutting down older large branches and reconfiguring many others to be smaller, less staffed and more customer centric. Surprisingly some banks are not moving this direction which I believe is a mistake. As I mentioned in another article, this is what younger generations are looking for. Thinking similarly to the way Apple works with customers is helpful to attract younger generations.
Although services are currently affected due to the pandemic, this is ingenious. Mobile branches can help serve communities where there are no branches but a large number of elderly residents looking to bank the traditional way. This is a cost effective yet smart investment to continue to reach customers. Before the pandemic Lloyds Bank had a total of 48 mobile branches servicing over 220 locations.
Form3 minority stake
LLoyds just took a minority stake in Form3, a cloud-powered payments technology provider. The stake will help Lloyds’ plans upgrade its legacy payments platforms by using Form3’s technology to enhance its payments capabilities. Which is yet another example of forward thinking to keep their bank relevant.
"Best Banking App in the UK: Lloyds Bank Mobile Banking app. based on a rating from Forrester in UK Mobile banking "
Lloyds has been investing heavily in order to reduce costs and improve efficiencies with their processes which is resulting in significant staff reductions. Additionally Lloyds has closed hundreds of branch locations and will continue to close more in the coming years as more and more customers move to mobile banking.
Lloyds Banking Group's share price is trading around USD 1.42 with a book value per share around USD 3.69. giving Lloyds Banking Group's P/B Ratio of barely 0.41. The book value clearly shows how depressed the stock is even after all of its efforts to cut costs and modernize.
First Half of this year
Lloyds recently reported an ungly quarter. The lender hiked its impairment charge to £3.8bn, which includes £2.4bn in the second quarter to June 30, 2020. This is due to the shutdown and posible prolonged economic downturn. Lloyds also expects increasing loan losses so they also plan to increase credit impairments to between £4.5bn and £5.5bn.
Lower net interest margin (NIM) of 2.59% plus more than 1.1mln payment holidays given to households pressured revenues and as a result income fell by 16% to £7.4bn. This combined with the much higher impairment charges, led to the statutory loss before tax of £602mln, a huge swing from the £2.9bn profit a year ago.
It's however interesting to see that although loan loss provisions have increased, its loan books continue to perform well, based on actual defaults to date.
Will Lloyds buy back shares?
In 2020 due to the extraordinary challenges presented by the COVID-19 pandemic, the Board decided that, until the end of 2020, LLoyds will undertake no quarterly or interim dividend payments, accrual of dividends, or share buybacks on ordinary shares. Additionally we believe that if the pandemic continues, the economy does not return to normal and Brexit overhang will likely mean no resumption of share buy backs anytime soon.
When will LLoyds resume paying dividends?
LLoyds Board will decide on any dividend policy and amounts at year-end 2020. Additionally we believe that if the pandemic continues, the economy does not return to normal and Brexit overhang will likely mean no resumption of dividends anytime soon.
Recently hedge fund Marshall Wace took a record £100 million short position against Lloyds. The London firm which manages over $40bn in assets is making a bet that the bank will continue to suffer from the political and coronavirus issues affecting the UK economy. This is interesting because Lloyds is a highly domestically focused bank. A bet against Lloyds is a bet against the U.K. However we believe the position could be a hedging strategy. Given the current turmoil, this is not surprising.
The aggressive investment in technology will continue to improve efficiency, reduced costs and eliminate on on-premise it infrastructure. This along with developments in AI and machine learning to help provide the best possible personalized experience will give Lloyds Bank a big advantage against its rivals over the long term. Additionaly cost reduction and controls will also help drive profits when Brexit and the pandemic are finally resolved. So we believe over the long term the company is setting itself up to become a modern highly efficient bank that will be able to return capital to shareholders.
The cancelled dividend and buybacks as well as brexit and covid-19 uncertainty has hit the stock hard. Loan losses could swell and the low rate environment is not helping. Basically it's a terrible banking environment over the short term and lloyds is a stock that is down and almost left for dead. However based on all the investments and cost cutting I believe this is a great value stock that is worth looking at over the long term. The share price does reflect all the bad news and it will not take much for this stock to appreciate in value. Looking forward we can see lloyds will be a highly modern and efficient bank that will have the ability to return capital to its shareholders. However over the short term this stock could continue to see pressure and lag the markets. Long term this looks like a buying opportunity, Potential investors should take the time and see if it should be added to their portfolio.
Other Bank Stocks?
Barclays (BCS) a multinational investment bank and financial services company, headquartered in London, England and Banco Santander, S.A (SAN), a Spanish multinational commercial bank and financial services company based in Madrid and Santander in Spain are other financial stocks we see value in as well. Value investors should take the time and review these stocks.
Disclosure: mysmallbank.com nor the author received any compensation from the mentioned security for this article. The article is our opinion only and is written to help readers learn more about the stock mentioned in this article. Consider this as basic information only and utilize professional services and additional sources before making an investment decision.