Interactive Investor

Why Lloyds Banking is among top share tips in Europe

21st March 2017 14:09

by Lee Wild from interactive investor

Share on

There are some big themes driving the market right now which throw up some great trading ideas. With that in mind, a team of strategists at UBS has crunched the numbers and come up with their top 40 highest-conviction stock recommendations that fit those themes.

Ten of UBS's best bottom-up ideas that fit its top-down views are listed here in London, including resurgent high street lender Lloyds Banking Group, oil major Royal Dutch Shell, and defence giant BAE Systems.

In terms of valuation and growth, it is perhaps easy to see why UBS has made its picks.

A weighted average price/earnings (PE) ratio of 14.5 for 2017 is a 5% discount to the Stoxx 600 index. That drops to 12.8 times and an 8% discount for 2018. Earnings per share (EPS) for 2017 is almost three times the index at 34%growth, the PE-to-growth rate of 0.6 is less than half the index, and a forward yield of 4.4% is far more generous, too.

First of the five macro themes generating those stock ideas is the commodity cycle. After providing the main drag on profits among European stocks last year, UBS thinks the base effect from the subsequent upturn in commodity prices "could be very significant".

That's an obvious boon for the likes of London's Shell, Petrofac and Glencore.

A return to revenue growth in Europe is also crucial, with inflation opening up the potential for positive surprises from the multiplier effect on earnings growth. That should trigger a recovery in historically low margins.

"2017 EPS forecasts are now pointing to significant margin expansion and this is being driven particularly by countries like the UK (where the GBP move helps with translation and transactional effects) and Italy," writes UBS, pointing to beneficiaries such as Irish building materials firm CRH, drug major AstraZeneca, Lloyds and Worldpay.

Given the consensus view is that monetary policy is reaching its limit, we're seeing a shift toward fiscal stimulus both here and in the US.

"Even if we are sceptical of the potential impact of an EU-wide program or that European GDP will see a vast boost; the impact on individual companies, especially in sectors such as construction, should be very significant," says UBS. "The fiscal stimulus might not be enough to materially move GDP – but it can materially move the EPS of stocks exposed to it."

Here, too, CRH is a stock to watch, joined this time by BAE Systems.

Interest rates won't stay at record lows forever either, and the US Federal Reserve's recent rate hikes may sharpen the mind of money men everywhere. There is a real chance that this could be the catalyst for corporates to refinance/releverage at current rates while they can.

And there's been a rush of activity in recent weeks, with Unilever in the thick of it briefly and Panmure Gordon targeted by Barclays' old boss Bob Diamond.

"The gap in levels of M&A activity between the US and Europe in 2015 and 2016 is the largest since 1998," notes UBS. "At that point such a large gap led to the largest jump in M&A seen in Europe since our data begins."

This could spell good news for Vodafone, reckons the broker.

And, finally, an uptick in the Eurozone consumer, particularly in Germany, is reason to get excited. We are already seeing the first signs of the impact, with German companies enjoying most favourable pricing power.

And house prices in Germany are growing faster than at any time since the 1980s. Again, Vodafone is well-placed.

The full top 10 is: Royal Dutch Shell, Petrofac, CRH, Glencore, BAE Systems, Burberry, AstraZeneca, Lloyds Banking Group, Worldpay and Vodafone.

Of particular interest is Lloyds Banking, the UK's most widely-held share.

And for those shareholders who may be wavering given expectations of an economic slowdown in the UK, UBS urges you to hold your nerve.

"In four of the last five UK recessions it paid to buy banks early," says analyst Jason Napier. "We see Lloyds as well positioned for a down-turn: capital levels look good, the loan portfolio defensive, liquidity is high and we see significant room to cut deposit rates and branch-distribution costs. Non-performing loan levels are modest, collateral levels high and, for now, unemployment is low."

And Napier is optimistic about the dividend.

"Lloyds targets 170-200 basis points of capital generation a year, worth 5-6p of potential payout power. Compounded by the completion of the government sell-down we expect by end May, we believe Lloyds offers strong income returns.

"We expect the stock to re-rate as resilience of margin and loan losses in a UK slowdown are proven," he adds, tipping the shares up to 80p.

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.

Get more news and expert articles direct to your inbox