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Could the Lloyds share price pop on a Brexit deal?

It seems almost impossible to predict whether the UK will leave the EU on October 31st with a deal, with no deal, or whether the UK will face further delay on the path to a final resolution. 

One thing that’s certain is Lloyds Banking Group and its share price would welcome a positive conclusion. Its price has dived 25% in recent months from 66.57p on April 17 to 50p today, with the growing chance of a no-deal Brexit a key factor in the fall. 

And along with Brexit problems came less-than-positive results. In its recent half-year update Lloyds [LLOY] reported a worse than expected 7% fall in profits to £2.9bn. Management blamed an extra £550m provision to cover a potential final surge in Payment Protection Insurance claims, ahead of the August 29 deadline, as well as an increase in charges for bad loans to £304m in the second quarter.

A no-deal Brexit would certainly make things worse. The bank is far more exposed to the UK than rivals such as Barclays [BARC] and HSBC [HSBA]. If a no-deal does unleash wider economic chaos - such as a house price crash - then Lloyds could be hit by consumers and businesses alike potentially defaulting on their loans.

In the second quarter Lloyds saw an increase in charges for bad loans to £304million. That’s the highest number since the second quarter of 2014 and raises concerns about the impact of economic uncertainty on both business and consumer borrowers.
Its already low net interest margin of 2.9% could also be hit by a further cut in rates by the Bank of England.

 

But wait, there could be a deal

But consider the opposite effect of a deal being reached. Lloyds fundamentals are in fact attractive, meaning its share price would likely gain with an end to Brexit uncertainty.

The bank understands its exposure to the UK economy and has taken a “prudent approach to growth and risk” resulting in 3% lower operating costs in the half-year and a £1.5bn investment in building a digital-first future. A focus on financial planning and retirement, including a new wealth management partnership with Schroders is also bolstering its model, with the bank aiming for £50bn plus of new assets by 2020. 

The PPI deadline also means the end of a £20bn headache that the bank has paid out in customer compensation.

“Management will want to draw a line under the PPI issue so the bank’s financial results can start to reflect its day-to-day business rather than endless ‘one-off’ items associated with compensation payments,” said AJ Bell investment director, Russ Mould. 

“Management will want to draw a line under the PPI issue so the bank’s financial results can start to reflect its day-to-day business rather than endless ‘one-off’ items associated with compensation payments” - AJ Bell investment director, Russ Mould

Lloyds continue to be a strong lender to UK SMEs and start-ups. Expect this figure to grow if a deal, which still leaves the UK in a single market or customs union, is reached. Business confidence will soar, and Lloyds will be a big beneficiary.

Similarly, consumer confidence will be lifted as people make delayed purchases of big-ticket items and decide now is the time to sell or buy a property.

 

Interest rates and dividend 

Any new deal and a subsequent lift to the economy would also bolster prospects of an interest rate rise – at least over the longer-term – to pre-recession levels.

There is also hope around Lloyds’ dividend. In its half-year results the company announced an ordinary dividend of 1.12p a share, up 5%, and re-iterated that it will start paying quarterly dividends in 2020.

Lloyds already has a prospective dividend yield of 6.1% - the second highest among the 51 FTSE 100 companies that offer earnings cover for the dividend of more than 2 times.

 

Market cap £34.37bn
PE ratio (TTM) 9.34
EPS (TTM) 5.30
Operating margin (TTM) 33.29%

Lloyds share price vitals, Yahoo finance, 03 September 2019

 

Lloyds stock also carries a PE ratio of 9.36, signaling a potential under-valuation, at least on an earning basis; an argument’s that strengthened when the metric is compared to that of Lloyds’ UK banking peers.

Earlier this year William Howlett, equity research analyst at Quilter Cheviot wrote: “We believe Lloyds offers a compelling capital return story reflecting the strength of its balance sheet and underlying capital generation.”

And Russ Mould of AJ Bell highlighted: “The shares also trade at barely 1.0 times net asset value, so it is possible to make a valuation case for the stock.”

But he added: “The prevailing low-growth, low-interest-rate environment is not a helpful one for banks’ profits or share prices – and it is starting to look like we could be stuck in that situation for some time to come.”

A good Brexit deal would lift that gloom, but Lloyds could have an almighty scare if the UK crashes out on Halloween.

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