Interactive Investor

My top four bank shares and why I don’t own Lloyds Bank

22nd December 2021 21:45

Lee Wild from interactive investor

Watch Nick Purves, co-manager of the Temple Bar Investment Trust, give his view on the outlook for income seekers in 2022. He also gives an excellent explanation of why he doesn’t go for jaw-dropping yields, and talks us through the trust's holdings in four major banks.

Lee Wild, head of Equity Strategy, interactive investor: Hello, with me today I have Nick Purves, co-manager of the Temple Bar (LSE:TMPL) investment trust. 

What do you think's in store for the trust in 2022?  Any big events in the diary or emerging themes you think will positively affect performance?  Are you worried about new COVID variants and how they clearly unsettle financial markets?

Nick Purves, co-manager of the Temple Bar Investment Trust: It’s very important to emphasise, we don’t make either economic or stock market forecasts because, I mean, sadly they're not really worth the paper they're written on.  What we try to do is we look at individual companies, their competitive position within their industries, we try and take a relatively conservative view of the outlook for the industry itself, form a view as to a particular company’s long-run profit and growth potential, and try and frame those in the context of today's valuation on the basis that if you can buy a reasonable business with a – you know, is able to offer a reasonable level of growth over time and you can buy that at a discount evaluation, then that should set you up for some good investment returns in the future.

And of course, you are going to get volatility along the way.  There's a lot of uncertainty out there at the moment, isn’t there? And obviously the latest strain of coronavirus is a great example of that.  But we always try to look through that and try to think long-term, and actually use any volatility or setbacks as an opportunity to add to positions at undervalued prices.

Lee: Well, things are looking up for income investors, and conditions continue to improve following the pandemic.  Are you more comfortable now with the outlook for dividends?

Nick: Again, it's a good question. Income investors have had a very torrid time, haven’t they, in the last couple of years. And I think income as an investment concept is very out of favour with investors, and I think we actually understand the reasons for that.  I think, you know, coronavirus did expose the unsustainability of a lot of the dividends that were being paid in 2019.  I think if you just look at the UK market, of the top 350 companies in the market by size, I think almost 150, or 40%, either cut or cancelled their dividends in 2020.  And that sends a very difficult message to income investors, doesn’t it?  Basically, it says you can’t rely on these dividends.
Important to recognise however that most of the dividend cuts that we saw last year weren’t by financial necessity, necessarily. They weren’t because the company was essentially trying to rescue its finances.  Most of the dividend cuts came because they were more precautionary in nature because we basically didn’t know in March and April last year how long coronavirus was going to go on for, and how much damage it might wreak on the economy.
Now I think obviously the vaccines have been brilliant, and I think the economies are recovering today at a rate that we wouldn't have dared to dream of at the beginning of last year.  And as economies recover, so profits in many sectors of the economy are obviously recovering very strongly, and that is leading to a strong recovery in dividends as well.
So actually, we do think the outlook for dividends is good from here.  As I said a bit earlier, the top 10 holdings in the trust are priced on a PE [price/earnings ratio] of nine, that’s an earnings yield of around 11, and it translates into a dividend yield of around 4%, so that’s on 2021 numbers.  So, a 4% dividend yield.  That’s not a bad level of dividend yield obviously given the prevailing level of interest rates obviously is so low.
What’s more than that of course is that those dividends are almost three times covered by the current level of profits.  Most companies you would normally expect around two times dividend cover.  And so, the outlook for dividend growth is also pretty good as that cover gets run down somewhat and as those earnings continue to grow.  So, yes, from today’s starting point actually the outlook for dividends we think is pretty good.

Lee: OK, there’s some really eye-catching high yields on offer in the FTSE350 index, especially among the miners and housebuilders.

Now why do these sectors not feature more heavily in your portfolio?  Are you sceptical about some of these headline grabbing yields?

Nick: Well, the miners do feature in the portfolio.  So, the portfolio has a significant investment in Anglo American (LSE:AAL), and then obviously we have – well, not obviously, but we have two investments in Newmont Corp (NYSE:NEM) and Barrick Gold Corp (TSE:ABX) which are both gold miners.  So, miners do make up a meaningful part of the portfolio.
It’s very important, the current level of dividend is not really the driver of the value of a share to its shareholders.  What’s most important is actually what we believe is the sustainability of that dividend, and therefore the sustainability of the profits that the company is generating. And I think we worry that some areas of the market are perhaps overearning, and that therefore the generous dividends you’re seeing today come out of these areas might not be sustainable.
So, dividend sustainability is really important and therefore is something we will shy away from those companies where we worry that those dividends, as I say, can’t be maintained over time.

Lee: Well, NatWest and Standard Chartered (LSE:STAN), among the banks they feature among your biggest holdings. I guess a question I've got is why those two banks and not, say, Lloyds Banking Group (LSE:LLOY) or Barclays (LSE:BARC)?

Nick: So, we do hold Barclays actually in a smaller position.  So, the trust has NatWest, Standard Chartered, Barclays, and Citigroup (NYSE:C) as well, the US bank.  We don't hold Lloyds, and I think there’s no particular reason for that.  I mean our guess is, is that Lloyds will, from today’s starting point, will do pretty well.  Again, that valuation is pretty low.  And the banks are recovering very nicely.  I don’t know if you remember, they had to take some pretty significant loan loss provisions last year against the potential defaults in their loan book as a result of coronavirus.  But these were largely guesses, I mean they were provisions, they weren’t actually seeing companies and households default at that time, and that has continued to be the case in this year as well.  The loan books are behaving extremely well.

And it’s not a surprise, therefore, that actually some of the banks have started to write back some of those loan loss provisions into their 2021 numbers.  We talked a bit about NatWest previously.  Again, standing at a pretty meaningful discount to its asset value.  Standard Chartered is probably the most attractively priced, that’s standing at around half – well actually slightly under half its book value today.  Again, we think over time the company should be able to make a 10 percent return on its assets which should argue for around a valuation of at least book value and possibly a premium.
So, we think the banks are in a relatively good place.  You obviously have to be a bit careful about how much money, how much of the trust’s money you have invested in any particular sector because in any sector you invest in, obviously there’s a chance that you’re wrong in your view of the prospects for the companies, and therefore it’s sensible to manage risk in that regard and therefore we try not to have too much in a particular sector.  But fundamentally we don’t have a problem with Lloyds at all.

Lee: Nick Purves, Co-Manager of the Temple Bar Investment Trust, thanks very much for joining me today.

Nick: Thank you.   

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