With most major markets heading north on rising optimism – or in the case of Shanghai, speculation – it’s time to get defensive ahead of the usually softer summer period. This week’s top tip has been chosen for its solid returns and low valuation.
Tip of the week: Lloyds TSB (LLOY), tipped as a BUY by The Daily Telegraph
Lloyds is the UK’s fifth-largest bank. Its operations are mainly at home
and are organised into three units: UK retail banking (representing 37% of profit before tax), insurance and investments (23%), and wholesale and international banking (40%). In 2006, Lloyds saw an 8% rise in underlying pre-tax profit to £3.7bn, helped by better performances from the retail and insurance units, despite bad debt charges rising 20% to £1.55bn. Total income grew 6%, giving earnings per share of 46.9p.
The cost-to-income ratio (a key measure of a bank’s efficiency) was cut to 50.8 from 52.8, largely due to the axeing of 4,167 jobs, or 6% of the staff. Eric Daniels, chief executive, said: “All cylinders are clicking and we’re doing things the right way. The solid fundamentals are in place and they provide a great platform for growth.” But the share price fell, as some analysts pointed to slower growth in mortgage lending, concerns over bad debts and disappointment that the chunky 34.2p dividend was not raised.
This looks unfair. Lloyds is right not to chase buy-to-let mortgages, where sky-high house prices and paltry yields look unsustainable. Avoiding sub-prime loans seems prudent, given HSBC’s recent US woes. Secondly, rising bad debts were partly due to overzealous debt management firms selling individual voluntary agreements (IVAs) as an alternative to bankruptcy. But the tide seems to have turned; insolvency and IVA numbers in the first three months of 2007 have stabilised, with the major banks tightening lending rules. Lloyds expects impairment-charge growth to be “significantly lower” this year than last.
Finally, at 34.2p, the dividend is hardly stingy, giving a hefty 5.8% yield. And at last week’s AGM, the group was upbeat, saying “it had made a bright start to 2007 and was on track to deliver a good first half”. Moreover, “it saw sustained double-digit profit growth over time, as it operates on a lower risk model that delivers higher quality earnings”.
There are always risks, such as a surprise crunch in credit or a UK recession. But Lloyds looks like a well-run business with strong brands, trading on an undemanding 2007 p/e ratio of 11.5 and paying a bumper dividend.
Recommendation: LONG-TERM BUY at 580.5p