SILVER BULLETS - Espirito Santo Investment Bank incorporating ...

THIRD QUARTER 2010
Lloyds Banking Group
Reaping the rewards of deleveraging
This is the fourth consecutive quarter we recommend LLOY as a
Silver Bullet BUY. This quarter, we are pairing the LLOY long with a
SELL call on BBVA. We continue to like LLOY for three key reasons:
1) the rigorous stress testing carried out by the UK's FSA in 2009,
which substantially improved the leverage profile of the bank (and
which should continue to improve as the group runs off assets and
retains earnings); 2) improving fundamental backdrop against which
LLOY should see materially lower levels of loan impairments
(£10.7bn for 2010E, v £24bn in 2009; 3) compelling risk/reward - we
estimate a tangible book value of 79p in 2012 and a 14pct ROTE. Our
fair value is based on 1.4x 2012 tbv/share and generates 112% upside,
which we view as extremely compelling.
Dividend paying capacity in 2012?
There is substantial optionality for shareholders of LLOY given a return to more
‘normal’ profitability levels by 2012. Further, as the EC mandated prohibition on
dividend payments to shareholders will be lifted at end 2011 (meaning that the
company can pay a full year dividend in early 2012 out of 2011 earnings), we
believe that LLOY will be in a strong position to pay a dividend in early 2012.
Assuming a 35% payout ratio (or £2.2bn), in-line with the current European
average, LLOY would yield 5.6% on its current market cap.
Rewards of de-leveraging
LLOY is set to reduce its balance sheet by c£40bn per annum through 2013.
Consequences are that the group will become fundamentally less capital intensive
(run-off businesses have a 3x RWA/loan load factor to the core business), and also
less reliant on wholesale funding (run-off businesses rely more on wholesale
funding than do core businesses).
Furthermore, while an improving leverage profile means cross-cycle returns in the
‘new world’ of 10-20%, though given an 81% correlation of price/tbv and leverage,
we surmise that investors will be prepared to pay a higher multiple for reduced
leverage and better quality equity base.
Figure 1: Leverage and price/book multiple progression: 1999 to Date
40.0
35.0
30.0
25.0
20.0
15.0
Source: ExecutionNoble
31/12/1999
30/09/2000
30/06/2001
31/03/2002
31/12/2002
30/09/2003
30/06/2004
31/03/2005
31/12/2005
30/09/2006
30/06/2007
31/03/2008
31/12/2008
30/09/2009
Leverage multiple (LHS) Price/book multiple (RHS)
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
http://www.execution-noble.com
BUY
112% upside
Fair Value 114p
RIC, Bloomberg Code LLOY.L, LLOY LN
Share Price 53.7p
Market Capitalisation £35,975m
Free Float 57%
£m (unless stated) 2009 2010E 2011E 2012E
Pre-provision profit 12,355 12,634 13,096 12,860
Pre-tax profit -6,815 4,416 8,249 8,991
Adjusted net profit 2,827 3,774 6,399 6,989
EPS adj (p) 4.1 5.6 9.6 10.4
DPS(p) 0.0 0.0 0.0 3.3
BVps(p) 63 68 78 88
BVps (adj) (p) 54 59 69 79
LLP as % loans -3.5% -1.7% -0.8% -0.7%
Cost income ratio (%)
Pre-APS
48.4% 45.5% 44.4% 44.2%
Figures are pro forma HBOS
X (unless stated) 2009 2010E 2011E 2012E
Adjusted P/E 13.0 9.5 5.6 5.1
Pre-provision multiple 1.9 2.8 2.7 2.8
Price / book 0.9 0.8 0.7 0.6
Price / adj book 1.0 0.9 0.8 0.7
Yield (%) 0.0% 0.0% 0.0% 6.2%
ROE (%) 7.4% 8.6% 13.1% 12.5%
ROE (adj) (%) 5.8% 9.9% 14.9% 14.1%
Core Tier 1 ratio (%)
Pre-APS
Figures are pro forma HBOS
8.0% 9.1% 11.3% 13.2%
Analysts
Joseph Dickerson
+44 20 7426 4228
joseph.dickerson@execution-noble.com
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