Morgan Stanley 'overweight' on Lloyds, Brexit outcome key valuation driver

Analysts at Morgan Stanley reiterated their 'overweight' stance and 60.0p target price for shares of Lloyds on Friday following a meeting with the lender's chief, Antonio Horta-Osorio.

In a research note sent to clients, analyst Alvaro Serrano said Lloyd's boss had struck a "realistic tone", talking him through a mix of organic and non-organic growth initiatives.

"Brexit is the obvious uncertainty, but reassurance was given around cost levers and management provided some sensitivity on provisions," Serrano added.

The lender's "severe" planning scenario envisaged a jump in the rate of unemployment to a peak of 8,6% and a 33.0% slide in house prices.

"Assuming a timely policy response, they think it would still be manageable resulting in a £2bn delta in provisions according to their models, which presumably would be absorbed by the removal of the counter-cyclical buffer," the analyst explained.

Regarding opportunities for non-organic growth, Serrano highlighted the purchase of Tesco bank as a good example and noted that management did not rule out other such purchases, having pointed out to him that Sainsbury's bank was contemplating a similar divestment.

Wealth Management and Insurance remained key, with management aiming to become a top-3 player in five years' time.

"The JV with Schroders is now up and running, and they will launch the non-advice platform for the <£100k segment, next year."

"The dividend is "sacrosanct" and hence why Lloyds cancelled the existing share buyback program. Any share buyback this year will depend on the final number of PPI and Brexit outcome. We estimate a 3.37p dividend this year and see a £1bn share buyback as more likely this year vs £1.75bn announced last year.

"Underlying market conditions continue to be challenging; however we see more resilient earnings than peers, and ultimately the Brexit outcome is likely to be the bigger valuation driver. We see Lloyds offering the best risk-reward, with the stock on 0.9x TNAV for a 12.3% ROTE in 2020E."

Under a 'bull' case scenario, with no significant macro deterioration in the UK and assuming "Bank of England raises rates by 25bp in 2021, and provisions increase to 25bp, allowing ROTE to reach c. 14% in 2020e and 2021e. £2.5bn share buybacks per year," Morgan Stanley estimated a target price for Lloyds shares of 85.0p.