Will 2015 see Lloyds return to the dividend list?

Otmane El Rhazi from Mindful Money » Shares.

Steve Clayton of fund and stockbroker Hargreaves Lansdown anticipates that 2015 will be the year when Lloyds Banking Group makes a decisive return to the dividend list, having been absent since mid-2008. He explains why…

Most analysts are predicting a token payment will be declared for the current financial year, but next year they see the dividend stepping up to meaningful levels. Consensus has Lloyds paying 1.1p for 2014, 2.9p for 2015 and then 4.1p in 2016. If those analysts are on the money, Lloyds would yield over 5% in 2016 if the share price were to remain at the current 78p.

The average dividend forecast of the nine analysts that have made a prediction for 2017 is 5.3p per share, which, if it happens, will be a yield of 6.7% on stock bought at the current price.

In a SIPP, or an ISA, there would be no further tax to pay. All this is far from assured, and indeed some analysts are predicting no dividend for next year. Nevertheless I believe 2015 will be the year it becomes clear whether Lloyds can become the cash-cow management envisage.

Let’s look at where we are now. Ever since the financial crisis, Lloyds has been either in theatre, or in the recovery suite. Their recent Strategy Day revealed a bank that was off the respirator, only making occasional use of walking aids and frankly now just waiting for the consultant to come around and say they were good to go home.

Take the balance sheet for example. The volume of impaired loans has more than halved to 4.5% of the value of closing advances, since 2011, whilst the amount set aside to cover any unrecoverable part of these loans has risen from 47% to 57% of their value. Given how much of Lloyds’ lending is secured, that looks like a conservative level of provisioning.

The loan book is behaving itself quite nicely these days; Lloyds view of a typical year sees a charge of circa 0.4% of the overall loan book to be taken against bad debt. This level of impairment hasn’t been seen since the middle of last year and the last few quarters have seen bad debts costing more like 0.2% per annum.

Underlying profits in the first nine months were up 35% to £6.0bn and cash costs were down usefully. Equity on the balance sheet, in other words the reserves available to cover bad news at shareholders’ expense, is up to 12% of Risk Weighted Assets, comfortably in excess of regulatory requirements.

Lloyds’ vision of the future is to be a large, but simple bank providing everyday banking services to predominantly UK citizens and businesses. The problem is that the market for those services is pretty well supplied, so growth will be linked as much to wider economic growth as it is to Lloyds’ attempts to snaffle market share from its rivals. The flip side is, that if the business is broadly plain vanilla stuff, largely conducted close to home with customers the bank already knows, then the risks for the business could be more manageable.

In the Bank of England’s Stress Tests, Lloyds was found to have sufficient capital to hopefully withstand a Doomsday scenario of sharply rising unemployment, inflation, interest rates and collapsing house prices and stock markets; a sort of Greatest Hits of the last three decades’ economic traumas. However, the pass was narrower than one might have hoped for, but as the Bank acknowledged, the Dec 2013 starting position used for the exercise took no account for the profits retained since then, nor the ongoing work to reduce riskier assets within the business, and so Lloyds was deemed to be fit for purpose, with no special measures required to be taken to further lift capital reserves.

This means, fingers crossed, that a decent share of the profits could be returned to shareholders as dividends, given the starting point of Core Tier One capital of 12%. And that is why I think Lloyds might surprise on the upside this year.

The way the economy is behaving, the business could prove robust and those future dividends should start to feel more and more tangible to the market. If the market starts to believe that the sort of payment some analysts are suggesting for 2017 is really a possibility, then income-seekers could come flocking. However, the emphasis needs to be on the longer term and, as with all dividends, these are variable and not guaranteed.

Nothing is without risk – PPI redress costs spring to mind here – and an election bring further uncertainty. But I think that a simpler, less risky Lloyds, run for the long term, could be a really interesting income proposition for the next few years.

Royal Mail sell-off underpriced by £180m

Otmane El Rhazi from Mindful Money » Shares.

The government’s privatisation of Royal Mail could have made an extra £180m, a report commissioned by Business Secretary Vince Cable has claimed.

The report led by former City minister Lord Myners concluded that the shares could have been valued up to 360p, 30p more than the flotation price, on the back of the high demand for the stock. The analysis however did go on to caution that if the £2bn initial public offering (IPO) price had been higher, it would have meant taking on “substantial” risk.

MPs have previously forecast that taxpayers lost out some £1bn in the 2013 privatisation.

Speaking on BBC Breakfast, Lord Myners said it was a “complicated transaction” and that “if any money had been left on the table it was pretty small”.

The report states while that a higher price could have been achieved it added that “the consensus appears to be that this was the order of 20p-30p per share… equating to proceeds to government at IPO of £120-180m”.

It adds: “For the avoidance of doubt, we do not believe that a price anywhere near the levels seen in the aftermarket could have been achieved at listing.

The value of Royal Mail shares surged went they hit the stockmarket in October 2013, rising by no less than 38%. As of 9:15 today, the shares in the FTSE 100 listed firm are trading at 398.7p, some 21% above their initial listing cost.

Gluttons for punishment – the only fun bit about value investing is the potential return

Otmane El Rhazi from Mindful Money » Shares.

Why would anybody want to be a value investor? It is a difficult, grim and – almost by definition – lonely existence. Take a glamorous area of investing such as personal computers and where are the value investors asks The Value Perspective’s columnist Kevin Murphy…

Are we piling into Arm Holdings because tablets are growing exponentially? No, we are buying the undervalued manufacturers of hard-drives and printers, which tablets barely use.

Clearly we are gluttons for punishment so you would imagine we must have a very good reason for pursuing a value strategy – and you would imagine right. It is effective. It works. From time to time, here on The Value Perspective, we mention our long-standing hunt for any academic study – carried out at any time, anywhere in the world – that has shown otherwise. We are still hunting.

When such academic studies examine the benefits of value investment, they tend to isolate more lowly valued stocks by concentrating on the cheapest half or perhaps the cheapest quartile or quintile of a particular market. That is, however, likely to be a lot of companies so that, for example, if you were looking at US data going all the way back to 1951, the cheapest quintile would number 170 stocks.

We know this because we asked our friends at Empirical Partners to crunch some numbers on precisely that data to see what lessons might be learned from the distribution of returns. No private investor, after all, is going to buy the best part of 200 stocks so what if we reduced the number to something a bit more manageable, such as 40?

Using that US data covering the period from 1951 to 2014, Empirical Partners isolated the 170 companies that made up the cheapest market quintile on free cashflow yield. Then, with the benefit of hindsight, they built three portfolios – the best-performing 40 stocks, the worst-performing 40 stocks and the 40 businesses that were bang in the middle. So what did that show?

As a whole, the cheapest quintile outpaced the wider market by 3.3% a year – sufficient to put it handsomely in the top decile of all funds over that period. Within that quintile, the ‘Best 40’ portfolio outperformed by an impressive 32% a year while the ‘Worst 40’ underperformed by 24% a year – some stocks are, after all, cheap for good reason. For its part, the ‘Middle 40’ outperformed by just less than 1% a year.

The lesson here for the would-be value investor is you can choose to go one of two ways – the first being you take the quantitative route and systematically buy the whole cheapest quintile with no exceptions. That is a perfectly logical approach but, if you do decide to take a more concentrated active path, we would stress that you cannot do things by halves.

If you think you can just cherry-pick a handful of stocks from that cheapest quintile and then outperform the market through some kind of divine right, you are potentially heading for a big disappointment. To succeed as an active value investor, you need to be a first-class fundamental stockpicker with excellent analytical and balance sheet-testing skills – or else you need to know someone who is.

Sports Direct shares are a ‘buy’ as retailer brushes off unseasonal weather and early UK World Cup exit

Otmane El Rhazi from Mindful Money » Shares.

Analysts at stockbrokers The Share Centre have cheered the latest market update from retailer Sports Direct International.

The firm, owned by billionaire Mike Ashley brushed off any market worries to report that underlying profit before tax jumped almost 10% to £160.6m over the six months to the end of October while revenues rose by 6.5% to £1.4bn and the earnings per share increased by 4.1% to 19.4p.

Commenting on the latest set of results Dave Forsey, chief executive of the group Sports Direct said: “The results for the six months were solid considering the adverse impact on performance during the period of England’s early departure from the FIFA World Cup in Brazil and the unseasonably mild weather during Autumn reducing footfall.”

Shares in the group, which operates hundreds of stores including the landmark Lillywhites located at Piccadilly Circus in central London, have eased by 12% over the past 12 months and the broker consensus has the stock in ‘buy’ territory according to Digital Look.

Helal Miah, investment research analyst at The Share Centre recommends Sports Direct as a ‘buy’ for medium risk investors looking for capital growth. He said: “In its first half results this morning, Sports Direct reported figures that were pretty much in-line with expectations. These figures should be relatively pleasing given England’s early exit from the World Cup and the unseasonably warm autumn weather dampening customer footfall. During the period the company has rolled out large format city centre stores, signed 26 new license agreements and continued to invest in inventory optimisation and product offerings. “

Following the update by 11.16am, shares in Sports Direct were flat on the day at 675p.