Income-seeking investors, be they institutions or individuals, are drawn to banks. They are, after all, rolling in wealth, offer high yields, solid dividend cover, high payout ratios, and have a nice habit of paying specials. Some even offer quarterly payments, helpful for anyone who relies on dividends as an annuity proxy to cover their day to day costs.
Recently, the sector has been making hay, in the form of rising net interest margins, in the sunshine of high interest rates. Banks, according to Computershare’s UK Dividend Monitor, paid out more in dividends than any sector last year, and are on track to make record payouts this year.
But one, Close Brothers, has suspended its dividend for now. That’s because banks are prone to scoring costly own goals, for example over exposure to a market, say Chinese property, or failing to spot a mis-selling scandal brewing, say in car loan protection sales — the issue that has scuppered Close’s dividend. Lloyds Bank hasn’t cancelled its dividend but, as it has a substantial share of the car finance market, its share price has been subdued.
Both are waiting to hear the decision of the City regulator on what any redress scheme might look like when the full report is published in May next year. It’s unlikely restitution will be as bad as the payment protection insurance compensation scheme, which ended in 2019 and cost UK banks close to £40bn. But it could be significant. Second time round, banks might finally learn their lesson.
BUY: Smith & Nephew (SN.)
It’s been an eventful year for Smith & Nephew thus far. But a shareholder rebellion over boardroom pay and the attention of activist investors haven’t overshadowed a solid trading performance, writes Mark Robinson.
The manufacturer of medical devices recorded a 19.5 per cent increase in operating profit to $328mn (£254mn), while generating $368mn of cash in the process.
The underlying trading margin rose by 140 basis points to 16.7 per cent. That put it at the top end of the guidance range, a result management said was driven by positive operating leverage and improvements arising from the 12-point productivity plan, not least in the area of procurement savings.
An area of concern at the time of the 2023 half-year results was the trading cash conversion rate, which then stood at just 26 per cent. It increased to 60 per cent in the period under review and is expected to revert to historical levels of around 85 per cent by the end of the year. Problems here, however, underline why management felt the need to implement a series of remedial measures. There was also a focus on improving the performance of the orthopaedics segment and management notes that implant availability has improved markedly with sales growth accelerating through the period. The price tag on restructuring costs relating to the efficiency and productivity work totalled $62mn.
The evolution of Smith & Nephew is highlighted in the high proportion of new business that is now generated from product lines that have launched over the past five years. The efficiency drive is already delivering material benefits which could conceivably feed through to broker upgrades in the wake of these results, so the forward rating of 18 times consensus earnings doesn’t seem overly daunting.
SELL: Just Eat (JET)
While adjusted cash profits rose 42 per cent, the statutory pre-tax loss widened, writes Christopher Akers.
Just Eat shares rose 9 per cent after the food delivery app delivered adjusted cash profits (ebitda) ahead of market forecasts and announced a new €150mn (£126mn) share buyback programme.
Ebitda rose 42 per cent to €203mn against the same period last year, driven higher by cost improvements in two markets.
In North America, where New York fee caps are denting performance and the company is still trying to offload the Grubhub unit it acquired for more than €7bn in 2021, profits were up by 57 per cent on “lower marketing costs and continued optimisation in operations and overheads”, while a lower delivery cost per order under a simplified operating model in the UK and Ireland resulted in a 64 per cent profit surge.
But the underlying performance was far more mixed than the share price boost would suggest. Order numbers were down 5 per cent, with a 9 per cent drop in North America. Gross transaction value (GTV) fell 1 per cent, with only Northern Europe and the UK and Ireland in growth. The statutory loss widened on lower revenue, and higher staff costs and impairment charges.
Management still expects constant currency GTV growth (excluding North America) of 2-6 per cent, Ebitda of about €450mn, and positive free cash flow before working capital movements for the full year. Free cash flow came in at a positive €38mn in the half, compared with a negative €78mn last year.
RBC Capital Markets analyst Wassachon Udomsilpa said the bank’s “bottom-up unit economics” suggests Just Eat can hit consensus ebitda forecasts for this year, but it is “cautious around its mid-term growth, in light of its reduced investments and an ongoing challenging consumer backdrop”.
There are still major concerns, around both the statutory performance and strategic direction, to address.
HOLD: Lloyds Banking Group (LLOY)
The black horse has a job to break out of a trot after a low-key set of results, writes Julian Hofmann.
Prior to the interims there had some heady speculation that Lloyds Banking Group might soon be able to overtake Natwest as the best-performing UK banking share after a solid six-month winning streak. Seasoned banking investors, used to many disappointments, take all such talk with a pinch of salt. In the absence of an upgrade to forecasts for the net interest margin for the full year – which is currently “greater than 290 basis points” – it seems unlikely that Lloyds will break into a sudden gallop on the back of these results.
Whether that gallop ever arrives is dependent on factors that are largely outside Lloyds’ control. As the bank is a broad proxy for the UK economy, recently brightening macroeconomic news will prove a positive as the year progresses. The £101mn booked in these results reflected better economic assumptions for the year ahead, which meant the bank was able free up £132mn of capital from its risk-weighted assets.
Another factor out of its control is exactly how the Financial Conduct Authority (FCA) will proceed with its investigation into allegedly detrimental commission payments for consumers who took out motor finance. The bank has not put aside any extra outlays to cover potential liabilities. The FCA is due to give its next update on the matter in September. For its existing remediation programmes, the bank recognised £95mn of costs, up from £70mn in 2023.
Loans and advances to customers increased by £2.7bn to £452bn. This included growth across most of its retail products, with £0.7bn growth in UK mortgages. Operating expenses of £5.45bn were 14 per cent higher, mainly due to depreciation in operating leases as car fleet sizes fell and prices for electric vehicle prices continued to slide.
It is possibly too early to judge how well Lloyds is doing. For example, the bank is still halfway through its latest five-year strategic plan, but it looks like it will achieve the £1.2bn of overall savings this year that is needed to underpin its financial forecasts. This means that key measures like return on tangible equity (RoTe) will come in as promised at above 13 per cent – RoTe was 13.5 per cent in these results.
Broker Peel Hunt puts the bank’s price to tangible net asset value at a punchy 1.2, easily the highest rating in the sector, although this is supported by its RoTe valuation. The run-up in the shares this year makes a change of recommendation dependent on Lloyds being able to sustain its momentum. The flat response to the results suggests it might be a while before the market is convinced.
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