I think you would be hard pressed to find a better blue-chip buy than Lloyds (LSE: LLOY) today.
This bank has everything. It’s a UK household name with growing profits, a strong balance sheet and the group is throwing off cash. On top of this, the Lloyds share price is currently cheaper than it has been at almost any other point in the last 10 years.
So, what’s wrong with the business? Today, I’m going to try and answer that question and explore why I think the Lloyds share price is the most undervalued in the FTSE 100.
Uncertainty
Looking at Lloyds’ fundamentals, it’s difficult to see any reason why investors wouldn’t like the stock. The bank itself is one of the most profitable and well capitalised in Europe, and it’s certainly more attractive, in my mind at least, than many of its UK peers.
However, it appears that many investors are still cautious when it comes to taking on financial stocks with the memories of the 2008 financial crisis still fresh in their minds.
Brexit uncertainty is only adding to the cautious sentiment. As the largest mortgage lender in the UK, Lloyds is the most exposed of all the big banks to the UK property market, and any downturn in home prices will lead to an uptick in loan impairments. This could force the bank to cut its dividend or beg shareholders for extra funds. But is this something investors should be concerned about?
I don’t think so, and it appears that the City agrees. Indeed, only a few days ago, credit rating agency Moody’s published a report stating that even “under a no-deal scenario, we expect the sector to remain profitable, albeit weakly so.” The report goes on to say that after a decade of building capital buffers, UK banks are exceptionally well prepared for even the worst case no-deal Brexit scenarios, which is excellent news for both customers and investors.
With this being the case, I think some of the negative sentiment towards Lloyds and its peers is overblown. While it’s unlikely that the bank will escape Brexit unscathed, I think the enterprise is well prepared to deal with any shock the next six months might bring.
Undervalued
Considering all of the above, I think the Lloyds share price is highly attractive at current levels. The stock is currently changing hands at a forward P/E of 8.1, which is around the same as the UK financial sector average. However, because Lloyds is one of the most profitable banks in Europe, I think it deserves a premium to the rest of the industry.
For example, this year management is targeting a return on tangible equity of between 14% and 15%. By comparison, last year HSBC reported a return on tangible equity of 8.9%, more than 40% below Lloyds’ return at the top end. Despite this discrepancy, shares in HSBC trade at a forward P/E of 11.2, that’s a premium of 38% to Lloyds’ valuation.
On this basis, I don’t think it’s unreasonable to suggest the Lloyds share price is undervalued by nearly 40%. There are few, if any, other blue-chip stocks with this much upside potential around today. A dividend yield of 5.5% only sweetens the deal for investors.
