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As interest rates continue on an upward trajectory, as well Lloyds (LSE:LLOY) shows, it seems. The bank’s stock is up more than 10% this year, and could climb even higher with the company set to report Q4 numbers next week. With that in mind, I will widen my position.
A cash machine
Lloyds’ recent strength in performance can be attributed mainly to an increase in net interest income (NII). It is the interest the bank earns on its financial assets, minus the interest it pays on its liabilities. And with about £80bn of assets on deposit with the Bank of England (BoE), Lloyds shares have benefited greatly from rising interest rates while generating free cash.
However, the rate hike is a double-edged sword. This is because higher rates usually lead to more defaults, which leads to higher disruption costs. However, Black Horse banks have been able to offset the increase in bad loans with a higher NII. This has resulted in overall profits getting a huge boost in the past year.
As a result, the stock is now close to a three-year high. As inflation remains high, the BoE is expected to continue raising rates, which will be a plus for Lloyds shares.
Interest gathered
This optimism is also unfounded. When Lloyds shared its Q3 results, the board updated the company’s guidance. As a result, more brokers turned bullish on the stock. That’s what he likes Goldman Sachs, Barclaysand German all have a ‘buy’ rating on Lloyds shares, with an average price target of 72p. Given that level of confidence, it’s no surprise to see expectations for Q4 numbers ahead of what the board had planned.
| Metric | Q4 2023 (Agreement) | Q4 2022 | Projected growth |
|---|---|---|---|
| Net interest income (NII) | £3.55bn | £2.89bn | 23% |
| Net interest margin | 3.16% | 2.57% | 0.59% |
| Impairment charges | £380m | -£532m | 171% |
| net profit | £1.21bn | £0.42bn | 188% |
| Return on tangible equity (ROE) | 12.5% | 2.9% | 9.6% |
With net profit forecast to more than double, Barclays expects to see Lloyds return “Primary sector return on capital” through dividend payments and share buybacks in the coming years. Blue Eagle Bank expects the company to generate around 45% of its £36bn market cap by 2025.
Banking in a good year
All this adds up to a strong tailwind for Lloyds shares in the short to medium term. In addition, the interest rate will remain longer, which will allow FTSE 100 stalwart to continue generating free cash from its assets. A shallower recession will help expand net interest margins, as depreciation charges are lighter. In addition, consumer sentiment is likely to take a turn for the worse, according to the bank’s business barometer.
| Metric | January | December | Growth |
|---|---|---|---|
| price expectations | 55% | 58% | -3% |
| Economic optimism | 47% | 43% | 4% |
| Business confidence | 22% | 17% | 5% |
| Confidence in the manufacturing industry | 28% | 13% | 15% |
| Construction industry trust | 27% | 29% | -2% |
| service industry trust | 25% | 18% | 7% |
| retail industry confidence | 7% | 13% | -6% |
That said, the windfall tax could be back on the agenda if profits continue to flood in when the economy suffers. The heavy tax will undoubtedly affect the group’s bottom line and shareholder returns, stopping it on its way to 60p and above.
However, I am still a Lloyds fan. The UK’s biggest lender has got a great set of financials. The CET1 ratio (after dividends and buybacks) is at 15%, while the liquidity ratio is healthy at 146%. What’s more, the current and future price multiples show that the stock is still reasonably priced despite its earnings. Therefore, I will buy more Lloyds shares before earnings next week, for long-term growth and passive income.
| Metric | Lloyds | Industry average |
|---|---|---|
| Price-to-book (P/B) ratio. | 0.8 | 0.7 |
| Price-to-earnings (P/E) ratio. | 9.0 | 10.1 |
| Price-to-earnings ratio (FP/E). | 7.7 | 7.3 |
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