Important: What follows is not a recommendation to buy or sell Lloyds. I’m just a private investor, storing and sharing notes. Read my disclaimer [1]. And remember that investing is best done via index tracking funds [2], not stock picks.
I have done a bad thing. Maybe. I bought Lloyds Group shares at 72p. Yes, greed has finally overtaken fear in my pondering of the banking shares. I can’t help thinking that this may be a once in a lifetime opportunity to buy a giant of tomorrow on the cheap today.
And so on Wednesday I placed about 2% of my portfolio in Lloyds.
I’ve owned the shares previously, and got out before they plunged 90% in merging with HBOS as I’ve written about before [3].
Why have I bought them again?
In short, because things change.
Regular readers may remember when I didn’t invest in Barclays at 220p [4]. I don’t regret that decision despite subsequent rises, because back then the market for banking shares was being driven by fear [5].
Instead I stuck to my picks of HSBC and Standard Chartered [6] to come through the crisis.
Standard Chartered is looking good, reporting excellent results and looking to make smart acquisitions.
HSBC has wobbled a bit, but I think its sheer size that makes it vulnerable in today’s thinly traded markets. HSBC is so huge, it needs to see more institutional buying, like a lot of blue chips right now.
But why buy Lloyds?
Regular readers will probably detect some psychological quirks [7] in the writing above. I’m trying not to write with too much hindsight bias, but perhaps that’s impossible.
Indeed, one of the reason I post some of my share picks on Monevator [8] is so that in future I can’t fool myself about why I bought a company, and what I expected from it.
In that spirit then, here are the main reasons why I’ve bought Lloyds.
I’ll try to keep it brief, since I’m aware huge volumes have been written about the ins and outs of banking stocks all over the place. Let’s stick to the essentials.
The threat of Government ownership has receded
Easily the most important reason.
In March as Lloyds shares fell towards 30p, there looked a serious possibility that the bank would be nationalised. Lloyds preference shares were at one stage yielding well over 25% – in retrospect an incredible buy.
But the government takeover didn’t occur. In fact, in early June, Lloyds became the first bank to pay back government money from the credit crunch.
The government now owns 43% – not pleasant, but survivable. I think the threat of nationalisation has passed.
Yet it still ring-fenced its assets
Lloyds entering the government’s asset protection scheme has shouldered lots of the dodgy HBOS loans onto the tax-payers’ shoulders, at a price of preference shares that can be excised at 150p.
The terms aren’t great, but crucially they don’t currently increase the government’s stake.
If the pref shares are excised at 150p (taking the government’s holding to 55%) I can make a new decision – and will have seen a 200% return by then, anyway.
Lloyds is dominant in the UK market
HBOS, which Lloyds ill-advisedly merged with during the panic of last year, was already the country’s biggest mortgage lender.
Add that to Lloyds’ existing book and it’s the market position is a mind-boggling one-third of the market.
It’s similarly dominant in savings, which will mean huge opportunities for good old-fashioned customer exploitation banking.
It’s slashing costs and jobs
Jobs are going left, right and centre at Lloyds, which is horrid for those concerned but the whole rationale for merging the businesses.
I was particularly impressed when Lloyds decided to close its Cheltenham and Gloucester network. As I say, I feel sorry for the employees, but it has to be done. And crucially, the government doesn’t seem to be stopping it.
The result should be most of the earnings of the combined companies (minus late stage nonsense earnings at HBOS) with much lower costs.
I like the Lloyds management
Seriously! Apart from their moment of madness when they bought HBOS (and I sold out) I have long admired the management’s sticking to the knitting, and paying a healthy dividend.
The Lloyds of two years ago is the model for retail banking of tomorrow. Dull, based on savings, mortgages, and some pretty innovative customer offers. More like a utility.
If a utility-style bank with access to the mortgages and savings of its 15 million customers can’t make money, then banking really is doomed.
Analysts see good earnings from 2011
Yes, I was swayed by the Goldman Sachs upgrade earlier this week, which is predicting Lloyds could earn 15p in the financial year after next (it will continue to lose money until 2011).
That would put Lloyds on a P/E of less than 5 on my buying price, when 10 would seem much more reasonable, assuming we’re out of the financial woods by then.
As for the downside, the asset protection scheme provides reassurance – it is writedowns that have been destroying banking earnings. We continue to save, buy insurance products, and pay our mortgages – at insane spreads at present. Banking should be very profitable again soon.
Assuming we don’t spiral into deep recession, I can see Lloyds getting back to 20p per share earnings within five years, which would make a share price of £2 very reachable.
Sometimes you’ve got to roll the hard 6
If you’re going to invest in individual stocks, you need to take some opportunities. There’s no doubt buying Lloyds is a bit of a gamble.
But the risk/reward – now the threat of it being taken over by the tax-payer has receded – looks pretty compelling.
I say again, this is a murky share to buy. There’s essentially no earnings visibility, we know there are lots of bad assets on the books, and as of now the U.K. is still officially in recession.
Buying Lloyds is basically a bet that sweating all those assets will out the earnings, eventually.
We’ll just have to see how well it does, and how fast – or otherwise – in the months and years to come.
Note: I take no responsibility for the accuracy of this post. Read my disclaimer [1].