Buy Lloyds, Sell RBS, Says Investec

Lloyds Banking Group PLC (ADR) (NYSE:LYG) (LON:LLOY) can return to positive EPS from 2014, while recovery at Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) remains very long and hence patience is required, notes Investec analyst.

Ian Gordon of Investec in his research reports dated July 4, 2014 notes scrip issuance, and share sales to neutralize the capital impact of paying coupons on subordinated debt by Lloyds Banking Group PLC (ADR) (NYSE:LYG) (LON:LLOY) and Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) have further contributed to an unhealthy culture of share count ‘drift’.

Reaffirms buy on Lloyds

The Investec analyst highlights that thanks to sharp outperformance witnessed in 2013, year-to-date, Lloyds has again performed relatively well in a sector context, albeit it has declined by 4% in absolute terms. As can be evidenced from the following chart, all UK banks have underperformed relative to the flat FTSE 100 (INDEXFTSE:UKX):

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The analyst anticipates Lloyds Banking Group PLC (ADR) (NYSE:LYG) (LON:LLOY) would return to positive EPS in 2014e and beyond. The following chart summarizes the analyst’s forecasts for EPS and DPS through 2014-16e after four solidly loss-making years witnessed during 2010-13:


The Investec analyst believes Lloyds Banking Group PLC (ADR) (NYSE:LYG) (LON:LLOY)’s earnings outlook appears increasingly predictable. The analyst points out that a year ago, Lloyds reported a 98% QoQ collapse in EPS in Q2 2013 reflecting non-recurrence of a raft of positive one-offs in Q1 and fresh PPI misselling provisions in Q2. The following chart captures Lloyds’ cumulative redress payments, including associated administration costs:

PPI-Lloyds' cumulative provisions and spend

However, the analyst points out that despite material uncertainties remaining, the analyst’s base case remains that Lloyds is now unlikely to require a further PPI charge.

Lloyd unaffected by mortgage growth decline

As highlighted in the following chart, the Investec analyst points out that with a forecast return to profit in 2014e and beyond, coupled with minimal share count drift, he anticipates the tNAV per share to recover to c.61p in 2016e, up from a low of 48.5p witnessed in 2013:

tNAV per share

The analyst notes as Lloyds trading on 1.3x 2015e tNAV, it offers reasonable further absolute upside on a 12-month view, augmented by the reinstatement of a token 2014e final dividend in February 2015.

Moreover, the Investec analyst doesn’t believe that Lloyds appears to be suffering any material adverse impact from slight softening in overall volumes of mortgage approvals.

On 1.3x 2015e tNAV, the Investec analyst reaffirms Buy with a RoE-g/CoE-g derived target price of 85p on Lloyds Banking Group PLC (ADR) (NYSE:LYG) (LON:LLOY).

RBS is a Sell

Ian Gordon of Investec in his research report notes capital is not one of the primary concerns in relation to Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS), though the analyst anticipates the group to remain modestly loss-making for the next two years.

The analyst believes a successful IPO of Citizens, with full exit planned by 2016, should eventually trigger a meaningful uplift for Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS).

However, the analyst notes the timeline of the RBS recovery story remains very long indeed. With 0.9x 2015e tNAV, patience is still required on Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) and the analyst anticipates a modest downside.

Hence with RoE-g/CoE-g derived target price of 325p, the analyst reaffirms his sell rating on Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS).