Could Lloyds shares be set to soar?

Lloyds (LSE:LLOY) shares are down 15% this year. It’s been a year of mixed signals with plenty of economic challenges weighing on the share price. 2022 looked like it would be a more stable year with the pandemic coming to an end. However, Russia’s invasion of Ukraine, rampant inflation, a cost of living crisis and subsequent interest rate rises have hurt the Lloyds share price.

But it hasn’t all been bad news. As the UK’s largest mortgage lender, Lloyds has benefited from a booming housing market while higher interest rates have seen margins rise. As a result, some forecasters expect the share price to soar. I agree and see Lloyds as a positive long-term addition to my portfolio. Here’s why.

A positive first quarter

The lender beat expectations in its Q1 update. First-quarter net income rose 12% to £4.1bn, reflecting double-digit increases in underlying net interest income and other income sources. However, underlying profit fell 7% to £1.8bn, despite cost reductions. The fall in underlying profit is partially due to a £177m impairment charge meant to protect the bank from inflation-induced defaults. Ignoring this, underlying profits increased 26%.

Impairment charges were less than the market was expecting, hence why the bank beat forecasts. Pre-tax profits came in at £1.6bn, ahead of the average forecast of £1.4bn. Income was also helped by increased mortgage lending. The open mortgage book rose £1.7bn in the first quarter alone. 

These figures reinforce a strong showing in 2021. Net income rose to £15.8bn, representing a 9% increase. Underlying net interest income increased to £11.1bn, a 4% rise. Pre-tax profits fell just short of expectations at £6.9bn.

Prospects

There might be some short-term pain for Lloyds. Mortgages account for 71% of Lloyds’ loans and it’s not clear where mortgage volumes will go amid a cost of living crisis and soaring inflation. Lloyds has raised these concerns. In the short term, interest rate rises may also dampen demand for homes. A slowdown in the property market would hurt Lloyds more than its diversified peers.

However, I’m bullish on long-term demand for property in the UK. After all there’s a shortage of housing which successive governments have not addressed. It’s also worth remembering that interest rates remain very low by historical standards too. This hasn’t been good for margins in recent years, but sustained higher rates could help margins in the long run assuming that consumers adjust.

The bank is also diversifying away from its core mortgage lending business. Through the brand Citra Living, Lloyds intends to buy 10,000 homes by 2025 and 50,000 homes by 2050. The lender has signed a strategic agreement with housebuilder Barratt Developments and something tells me it’ll get a good deal.

Lloyds is also looking to expanding its wealth management, asset management, insurance and pensions offerings. The group has invested £4bn over five years, indicating how seriously Lloyds is taking its shift. Will it pay off? Only time will tell, but diversification probably wouldn’t hurt if it’s done well.

Should I buy?

I’ve already bought Lloyds shares and will buy more. It’s got a price-to-earnings ratio of just 5.6 and I don’t think that’s indicative of its strong future prospects. I can see Lloyds stock soaring in the coming years although I don’t see it breaking out of penny stock territory any time soon.

This post was originally published on Motley Fool