Stuart Mitchell of S. W. Mitchell Capital presented his investment thesis on Lloyds Banking Group (UK: LLOY) at European Investing Summit 2022.

Thesis summary:

Lloyds Banking Group has been a frustrating investment. Stuart first purchased the shares in the depths of the Great Financial Crisis at £22, with a price target of £100. The shares briefly rose above £80 before falling back to £45 recently. Stuart still, however, believes that shares are worth well over £100.

Lloyds is the dominant UK bank, with 17% market share in lending. The bank has the lowest cost-income ratio in the sector (57%), boasts the most excess capital (16.3 % CET 1), and has a coherent strategy to develop its asset management business through a joint venture with Schroders and Cazenove.

Like other banks, Lloyds has faced a number of headwinds over the past twelve years. In the wake of the Global Financial Crisis, politicians across the world looked for ways to strengthen the banking system. The result was a significant increase in bank regulation. Above all, banks were forced to hold significantly more equity capital than in the past.

Lloyds also had to face much lower interest rates, the principal policy tool used to manage the crisis. This was difficult for the banking sector to cope with: funding costs take time to fall, while customer account balances remain essentially fixed.

The outlook appears to be improving. Rates are rising, and this will dramatically boost revenue. At the same time non-performing loans remain relatively stable. Just as importantly, regulatory intensity could be stabilizing. Investors may recall the (controversial) decision in March 2020 by the Prudential Regulation Authority that banks should suspend payments as the pandemic took hold. This mandate has been removed and the conservative government is thought to be more supportive of the industry.

At a tangible book multiple of less than 0.8x, Lloyds shares appear undervalued as the group may once again earn a return on equity in excess of 14%.

Read a related article by Stuart on finding bargains in European banks.

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About the instructor:

Stuart Mitchell is the Managing Partner and CIO of S. W. Mitchell Capital and the Investment Manager of the SWMC European Fund, as well as a number of managed accounts.

Prior to founding SWMC in 2005 Stuart was a Principal, Director and Head of Specialist Equities at JO Hambro Investment Management (JOHIM, now Waverton Investment Management). At JOHIM he set up and managed the Charlemagne Fund, a long/short European fund, and the JOHIM European Fund, a long only European fund. The JOHIM European Fund rose by 133% since inception in December 1998 until March 2005 compared with 8% for the benchmark index and was number 1 rated by Micropal within its sector and three star ranked by S&P.

Upon leaving university in 1987 Stuart joined Morgan Grenfell Asset Management (MGAM) and soon afterwards assumed responsibility for managing the continental European equity assets for MGAM’s British pension fund clients. Stuart was appointed a director of MGAM in 1996. He was then made Head of European Equities and was responsible for $27 billion of equity assets. Whilst at MGAM he managed the Morgan Grenfell European Fund which rose by 123% from January 1990 to June 1996 compared with 85% for the benchmark index and was awarded 1st place by Micropal (5 year awards) in 1996.

Stuart was born in Scotland and educated at Fettes College and St. Andrews University where he read Medieval History. He is also a graduate of the Owner/President Management programme from the Harvard Business School. Stuart speaks English and French.

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