Raising Fair Value Estimate for Lloyds Stock After Earnings

Key Morningstar Metrics for Lloyds Banking Group

• Fair Value Estimate
  : GBX 111
• Morningstar Rating
  : ★★
• Morningstar Economic Moat Rating
  : Narrow
• Morningstar Uncertainty Rating
  : Medium

What We Thought of Lloyds Banking Group’s Earnings

Lloyds reported first-half underlying profits of £4.2 billion, up 18% versus last year. Solid income momentum in both interest and noninterest income, paired with flat operating expenses, created a positive operating leverage effect.

Why it matters: Lloyds runs a large mortgage book, which is a competitive market. The headwind from pricing remains in mortgages, but is offset by a strong contribution from the structural hedge. The banking net interest margin expanded 5 basis points from the first quarter to the second quarter.

• Lloyds is focusing on a cross-selling strategy to leverage its large mortgage book and expand volumes in unsecured and commercial loans, driving a solid income performance across interest income (up 9%) and other income (up 11%).
• Operating expenses were flat year over year as cost savings and lower severance payments compared with the first half last year offset wage inflation and business-as-usual growth investments. We think full-year guidance of costs below £9.9 billion is achievable given this result.

The bottom line: We increase our fair value estimate to GBX 111 per share from GBX 97 per share previously. We have lifted our net interest margin expansion assumption through 2028 and model a higher operating efficiency, assuming more cost savings to structurally lower the cost base.

• Our new assumptions allow for a greater capacity for capital distribution to shareholders. We now model a progressive dividend with a payout ratio of 45% and £3 billion in share buybacks per year.
• With base-rate expectations firmly pointing toward hikes over the next couple of years, we have lifted our net interest margin assumptions by 10 basis points. We now think that the structural hedge tailwind can offset more of the margin pressure headwinds in our explicit forecast window.