Q1 results preview: Lloyds and the bank sector

For investors in Lloyds Banking Group (LLOY) and other UK banks eyeing an uplift to moribund share prices in the upcoming results season, the message is simple: “Don’t hold your breath”.

Even though UBS thinks that UK banks are cheap in absolute and relative terms, the bank warns that Q1 figures will not provide much of a catalyst to change sentiment one way or the other.

The main problem is that it’s too short a period since the City last heard from management, with recent trends consistent with those reported in February.

All is not lost, though, as UBS remains a fan of the UK domestic banks Barclays (BARC) and Lloyds and is more positive on Royal Bank of Scotland (RBS).

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UBS’s Jason Napier also expects bank management teams to use the forthcoming results to show “increased confidence in the outlook, laying the groundwork for a re-rating of the domestic banks in particular.”

Napier believes that current consensus expectations for margins and loan losses, valuation and investor positioning are all too negative.

International investors have shunned UK banking stocks, in part due to the uncertain outlook caused by Brexit negotiations. But the European banking sector has also been weak, falling by 4% this year and underperforming the market after appearing to bear the brunt of geopolitical uncertainty.

Looking ahead, the imminent rise in the Bank of England base rate should help margins, while UBS forecasts a pick-up in UK real GDP growth in the next two quarters.

These factors will protect banks including Lloyds against the ultra-competitive mortgage pricing conditions in the UK.

UBS expects Lloyds to report a margin of 2.91%, which is broadly in line with the fourth quarter run rate and the company’s own forecasts for 2018.

Lloyds is one of the broker’s top picks in the European banking sector, with a price target of 87p ahead of next Wednesday’s first quarter figures. Adjusted profits should be just under £2.3 billion.

According to Napier, Lloyds is attractively valued, trading at 8.7x current year’s earnings and with £1 billion of share buybacks planned for 2018 helping to reduce this forward multiple to 7.8x in 2020E.

He added: “During this time we also expect a healthy level of dividend income, yielding between 4.8% and 5.5% each year, before buybacks.”

UBS’s stance on Barclays is also positive, with a price target of 245p. But CEO Jes Staley may need more than that to placate activist shareholder Edward Bramson, who has taken a 5% stake in the bank with a pledge to double the share price.

Having said last summer that it wouldn’t be long before shareholders could finally plug into “the full earnings power” of Barclays, Staley vowed in February to return the 2018 dividend to where it was two years ago.

UBS thinks that Barclays is attractively valued, trading at 8.8x 2019 earnings per share (EPS), with buybacks expected to help the metrics substantially over the next 2-3 years. The projected dividend yield for 2019 is 3.3%.

One other area of interest will be whether Wall Street’s muted reaction to better-than-expected results from the likes of JP Morgan will be repeated should Barclays achieve a better outcome in its markets business.

A return to paying a dividend at Royal Bank of Scotland is contingent on a settlement with the Department of Justice for mortgage securities mis-selling. This is the last hurdle after the bank recently agreed to pay an additional £3.5 billion into its main pension scheme.

UBS has pencilled in a dividend of 11p a share in 2018, rising to 22p the following year. Its target price of 290p is based on trading at 9.5x 2019 EPS.

The NatWest owner is due to report Q1 figures next Friday, one day before Barclays. UBS is neutral on HSBC (HSBA) and Standard Chartered (STAN) ahead of their figures due on May 4 and May 2 respectively.

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