Lloyds (LSE:LLOY) shares fell as much as 5% in early morning trading on Wednesday as the market reacted negatively to its H1 earnings report. Despite the tailwind associated with higher net interest margins, the bank is now down 12% over six months. So will Lloyds shares recover, and is this a buy opportunity? I certainly believe so.
Investors underwhelmed
Despite Lloyds Bank reporting an impressive surge in earnings driven by higher interest rates, investors were underwhelmed. Key takeaway include:
- Pre-tax profit of £3.9bn for the six months to June, below the £4bn forecast by analysts
- Underlying net interest income showed a significant 14% increase, amounting to £7bn
- Net interest margin fell to 3.14% in Q2, from 3.22% in the first three months of the year
- Lloyds took a £662m impairment charge in the half, up 76% from last year
Lloyds did take steps to please shareholders by raising its interim dividend to 0.92p per share, a 15% increase from the previous year. Additionally, the bank lifted its return on equity guidance to more than 14% for the full year, surpassing the previous estimate of 13%. However, the bank shied away from share buybacks, contributing to further disappointment.
Will Lloyds ever recover?
The stock has lost around 30% of its value of the past five years. And I can’t help think that investors are too keenly looking for the downside, rather than any upside.
In this case, a 24% increase in year on year profits resulted in the already depressed stock value falling. We can attribute some of this to the extreme pessimism surrounding the UK economy, and especially cyclical stocks like Lloyds.
However, ever the optimist, I have hope for Lloyds. Firstly, we have to look at valuation. The UK’s largest mortgage lender trades at just six times forward earnings. That’s remarkably low, and reflects half the average price-to-earnings for the FTSE 100. This is the type of price-to-earnings ratio we’d expect from a company with very little growth potential.
But I don’t believe that’s the case. Firstly, Lloyds is likely to benefit from forecast falling interest rates later in the year and into 2024. That’s because lenders tend to perform best when central bank rates are at a moderated level — between 2% and 3% — where net interest margins remain elevated but impairment charges fall.
Moreover, Lloyds is undertaking significant changes to its business, which should allow for greater growth rates in the coming years. Its strategic plan includes deepening relationships with its 26m customers by over 5% by 2024 through personalised engagement and innovation in digital banking.
It also aims to digitise and diversify their SME business, expanding into products and sectors with lower market share. Additionally, the company plans to introduce a new mass affluent offer to target an underserved market segment and attract high-value customers across banking, protection, and wealth services.
The biggest concern for investors is likely the pessimism surround the UK economy, rather than increasing impairment charges on bad debt. For me, it’s a value stock I keep topping up on, and it will recover. The big question is, what will send the share price higher?
