New position: Lloyd’s Banking Group (GBGB0008706128) as special situation investment

Interestingly, while looking at AerCap, I always almost automatically compared them to Llyods Banking Group. In the old days I might have bought both shares but as I limit myself to 1 new position (or one complete sale) per month I had to make a decision and it went to Lloyds. My previous analyses can be found here: part 1 & part 2

Just to summarize my view on Lloyd’s and why I bought now:

1. I do think UK retail banking is a structurally good business in the mid- to long term
2. Lloyds does have a certain “franchise” and good management
3. I like buying into uncertainty (UK election). Most investors hate uncertainty and often political uncertainty provides interesting entry points
4. Continued heavy selling by UK Government has a direct impact on the price. This is from a few days ago:

Lloyds Says U.K. Treasury’s Stake In Bank Falls Below 21%
By Keith Campbell
(Bloomberg) — Govt now holds 14,955m shares, down from 15,697m Govt had cut stake to 22% as of March 25

Within 4 weeks,the UK Government sold almost 750 mn shares. Total trading volume according to Bloomebrg was ~2,6 bn shares, so the selling program accounts for ~29% of the total traded volume. Normally, 10-15% of daily volume is already critical, but dumping almost 30% of daily trading clearly must have an impact on the price.

I am not sure why the Government is still “dribbling” out (at this pace it is rather “pumping out” shares) instead of placing the whole amount but I guess that has to be with political tactics, i.e. not leaving this around for the next government

5. Lloyd’s is taking market share from competition (via Halifax):

Lloyds Banking Group Plc’s Halifax unit gained the most customers from its rivals of any U.K. lender in the third quarter as probes by the competition watchdog and financial incentives resulted in more Britons switching banks. Royal Bank of Scotland Group Plc and Barclays Plc lost the most U.K. checking accounts in the period, the most recent data published by Britain’s Payments Council on Thursday show.

6. HSBC is doing everything to destroy its reputation on UK’s high street by threatening to leave the UK. Also the other big players (Barclay’s, RBOS) have other problems
7. Compared to AerCap, increasing interest rates should be overall positive for banks
8. the major risk for the LLoyd’s investment case is relatively independent to overall markets (UK regulation, PPI, election)
9. results and dividends will improve more or less automatically over the next 2-3 years even under relatively adverse developments
10. I said this a couple of times, but for me a regulated retail bank like Lloyd’s is less risky than a “shadow bank” financing company like AerCap. If there is a next finanical crisis, in my opinion traditional banks will be less effected than “non traditional” players

Similar thoughts to my own can be found at teh UK version of Motley Fool just a few days ago.

There is clearly also a potential downside:

– there are no prominent investors like Einhorn and Jana on board and no direct “catalyst”, so stock price could remain “range bound” for some time
– clear tail risk with regard to UK election outcomes, “Brexit”, bank levy etc.
– Q1 could again look not very nice (TSB charges, bond repurchase)
– if interest rates in the UK go “European”, profitability could suffer in the long term
– Lloyds has pretty low beta and will underperform in a “Good market” for some time

Anyway, to me Lloyd’s banking Group looks like an interesting special situation at this time. The share overhang and selling should clear at some time, profits will most likely increase. Over 3-4 years I look for an upside of around 50% plus dividends or ~15% p.a. if my assumptions turn out to be correct.

I therefore established a 2,5% for the portfolio at around 0,77 GBP per share for my “special situation” bucket.

If because of the election or a share placement the price will go to around 70 pence I would increase the position. A reason for selling would be for instance the departure of the CEO.

Disclaimer: Please note that this is not meant as investment advise. Never trust stock tipps anyway. DO YOUR OWN RESEARCH and in most cases index funds are the best investment alternative anyway

Edit: This was clearly pure luck that the day after I bought, Lloyds jumped already almost +7%. As I had expected, net income was lower compared to Q1 2014 but operating profit was up significantly and investors seem to have been positively surprised.

6 comments

  • “Q1 could again look not very nice”
    Got it wrong already, results were nice. Couldn’t pick better timing 🙂

    • Well, total profit after tax actually declined against Q1 2014 because of the TSB “one off”. So I would assume that I was right but the market didn’t care or expected worse results.

  • why dont you buy an equally cheap us bank instead, surely more dynamic (more stable LT) and healthier country, not late cycle either (which your SHB investment would have been)

    • Lloyds is a “special situation” investment. SHB would be rather a grwoth case but it is too epensive at the moment. Overll, I think Lloyd’s is very stable and has a lot of petential to surprise to the upside.

      • What a timing you chose. Congrats, that’s the perfect way to start a new ownership! Coming back to the US question, why not JPM for example (PEx12)? healthy cf while hike in interest rates might improve lending margins (a different question is whether or not there will be hike in interest rates…Atlanta FED has just announced Q2 GDP forecast at mere 0.9%).
        Thx

        • #Dave,

          JPM is one of the best run banks out there, I agree. On the other hand I do think that at the current situation, Lloyds looks more interesting. I do think their business model is less risky and they will be less effected by the “Anti Megabank” tendencies globally.

          mmi

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