How Lloyds shares can top 100p

A retail investor favourite, Lloyds is making headlines again - and for all the right reasons! The bank smashed its profit and dividend targets this week, and - after going over the numbers - the City is confidently waiting for more.

Financial strength means investors can look forward to a bumper dividend payout over the next three years, which is why analysts at Barclays are still backing the high-street lender.

Climbing 5.5% since Wednesday morning, Lloyds is back to pre-referendum levels above 70p, and is changing hands for 9.6 times forward earnings. Rohith Chandra-Rajan reckons the shares are worth 7% more at 75p, so repeats his 'overweight' rating.

"We see Lloyds making a consistent c13% [return on tangible equity (RoTE)] over the next three years and returning almost a quarter of its market cap to shareholders which suggests that the shares are undervalued," explains analyst Rohith Chandra-Rajan.

"This is supported by a relatively resilient UK economic outlook and some margin expansion."

But Barclays thinks downside is limited even if economic forecasts are too optimistic. In fact, if returns from higher revenues improve faster than expected, provisions are lower, and uncertainty around Brexit is overdone, capital returns could increase further and the shares reach a peak of 114p.

And, taking advantage of the share price recovery, the government has sold another 791 million Lloyds shares, trimming its holding in the bailed-out lender to 3.89%. It comes a month after the Treasury took its stake below 5%, and brings a complete removal of the shares overhang another step closer.

With reported profit more than doubling from £1.6 billion to £4.2 billion in 2016, Lloyds is in much better financial shape than it was 12 months ago: the common equity tier 1 (CET1) ratio grew by 190 basis points to 14.9%, excluding dividends. It's why the bank was able to confidently pay a special dividend of 0.5p, on top of its 2.55p ordinary payout.

Barclays reckons investors should expect even more. As Lloyds' acquisition of MBNA's UK credit card book was fully funded, earnings can either immediately be returned to shareholders or help grow the business.

Reflecting a 6% yield, analyst Chandra-Rajan has upgraded his 2017 dividend forecasts by 11% to 4p in 2017, growing to 5p by 2019, underpinned by margin strength and improving efficiency.

If Lloyds delivers the anticipated 14% RoTE, the bank could return around 20% of its £47.6 billion market capitalisation to shareholders by 2020, argues Barclays - that's around £9.5 billion.

It's certainly possible Lloyds can deliver on these dividend hopes. With deposit costs falling, a stronger net interest margin outlook should offset weaker income from non-interest income business in 2017.

Chandra-Rajan upgrades earnings forecasts by 4% to 7.4p for this year and by 2% in 2018. Pre-tax profit should jump by a third to £5.7 billion this year, and is on track to deliver a 20% compound annual growth rate over the next three.

And there's scope for investors to get even more as Barclays' forecasts include nearly £5 billion of charges, including restructuring costs, amortisation of intangibles and conduct provisions. With £2.2 billion ring-fenced for the latter, their analysts admit they may have erred on the side of caution here.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.