Lloyds (LSE: LLOY) is among the most followed stocks in the UK, and today the bank is a flagship of British business. However, as most investors will know, it wasn’t always as strong as it is now. A taxpayer bailout in 2008 brought Lloyds back from the brink after its ill-fated HBOS deal.
Still, today Lloyds is miles away from the basket case it was nearly a decade ago. Indeed, the bank is on track to become one of the UK’s top dividend stocks.
Top dividend stock?
The two most important qualities of a dividend stock are financial stability and high-quality earnings. Lloyds ticks both of these boxes. After 10 years of restructuring, the company has shed non-core assets, cuts costs to the bone, and refined its focus on the group’s most productive assets.
Its first quarter results, which were published yesterday, show just how successful this restructuring has been.
The bank’s Tier one capital ratio hit 14.3% at the end of the quarter, up from 13.8% at the end of 2016. For the year, management expects capital generation to be “at the top end” of the 170-200 basis points range, which could leave the bank with a capital ratio of more than 15%. And this impressive cash generation is unlikely to end any time soon. Lloyds is planning to cut costs further in the years ahead, targeting a cost-to-income ratio of 45% by 2019, down from 47.1% today, implying wider margins and fatter profits in the years ahead.
Put simply, now Lloyds has, if anything, too much cash and management will have to decide how the business decides to use this money in the months and years ahead. The bank has already used some capital to fund the acquisition of credit card provider MBNA, but it’s more than likely that Lloyds’ management will stay away from any more significant acquisitions as past purchases act as a warning not to be too ambitious. And what does this mean for investors? It’s likely management will favour cash returns — great news for its shareholders.
Dividend champion
In the past, Lloyds has said it will look to return capital to investors if its capital ratio exceeds 12%. With a capital ratio nearing 15%, the bank will have billions of unwanted cash to dump in investors’ laps. City analysts are forecasting that the bank will pay out 3.6p per share in dividends this year and then 4.2p for 2018, which works out as yields of 5.6% and 6.4% at current prices. These impressive forecasts may be underestimating Lloyds’ dividend potential considering all of the above, and I wouldn’t rule out additional special dividends from the bank in the years ahead.
So overall, based on first quarter numbers, it looks as if the company is set to become one of the UK’s best dividend stocks this year. With a strong balance sheet and highly efficient operations that are throwing off cash, the Lloyds payout looks as if it’s here to stay and there’s plenty of room for growth.
