Lloyds Banking Group’s black stallion has bucked, and spooked the rest of the stable. The UK high street bank on Thursday added another £2.4bn in provisions for loans it thinks will go bad, a figure far worse than analysts had anticipated for the quarter.
The bank’s change of heart over the fortunes of the UK economy were to blame. Three months ago, Lloyds — considered a UK bellwether by virtue of its scale and domestic retail banking focus — took a comparatively optimistic stance. That horse has bolted.
Lloyds’ new base-case scenario puts both growth and unemployment at worse levels than its most pessimistic view back in April, and below those of Barclays. The middle path now pegs GDP for the year down 10 per cent, unemployment at 7.2 per cent and house prices down 6 per cent. If things go better, the bank does not reckon it will be by much. It does think they could get much worse, though. Unemployment peaked at 8.5 per cent in the wake of the financial crisis. In Lloyd’s worst-of-the-worst-case scenario, that figure could be 12.5 per cent come the second quarter of next year.
Investors scrammed, lopping 8 per cent off the share price on Thursday. Worse, Lloyd’s melancholy has proved contagious. Declines in NatWest and HSBC were predictable enough since both will set out their own expected losses in the days ahead. But Barclays and Virgin Money caught the bug too. Both had already disclosed their best estimates of the crisis’ impact earlier in the week.
Lloyds’ provisions are not necessarily as bad as the investor exodus makes them seem. For the full year, the bank reckons the total will be between £4.5bn and £5.5bn, of which £3.8bn fell in the first half. Analysts had been counting on about £5bn for Lloyds anyway. The timing of when it takes those charges, driven by new accounting rules, should not matter so much.
Still as a proxy for the UK economy, what is bad for Britain is bad for Lloyds. Higher unemployment and falling house prices will hurt. The bank’s forecast for net interest margin for the year was worse than analysts expected.
Lloyds has baffled investors with its provisioning before. In the early months of 2011, the bank took a £3.2bn hit — boss António Horta-Osório’s “best estimate” of the cost of the payment protection insurance scandal. Kitchen sinking, critics said. PPI eventually cost the bank about £22bn. Optimism did not serve AHO well. This time, with Lloyds not to blame for its new misfortune, there is no shame in frightening the horses.
Roll up to Rentokil
Roll up, roll up. After a dismal decade and a half in the early 2000s, ratcatcher Rentokil has made a tidy business out of rolling up small pest control outlets in recent years. Its shares were among the few risers during a dismal day for the FTSE 350. Half-year results showed just how well its hygiene-to-pest-control portfolio has cleaned up.
True, the days of Mr Twenty Per Cent Clive Thompson are well behind the company. He promised 20 per cent annual profit growth during his 20 years as boss at the end of the last millennium. Last year, operating profits for the ongoing businesses in the M&A-mad group increased more like 11 per cent. Coronavirus disruption this year meant a 9 per cent fall in the first half of 2020.
But acquisitions of mom-and-pop pest control units picked up for a few million here and there have worked well for the group. Catching critters generates good margins: 18 per cent last year, with room for further improvement particularly in North America. Shifting focus further towards the business, which made up 68 per cent of profits last year, has supported the shares. Last year, the stock returned to its “Twenty Per Cent” era highs.
Until coronavirus came along, though, analysts fretted the company’s shares were fully priced. Growth was becoming more difficult as others piled into pest control M&A, pushing up the price of acquisition targets. Fears over Rentokil’s ability to pull off promised margin progress in North America mounted.
Its resilience through Covid-19 has revived the company’s defensive growth appeal. Its steady stream of contractual income held up surprisingly successfully through the second quarter considering offices and schools were closed across many of its markets. Pest control sales fell 6 per cent in the three months to the end of June, but still ended the half up 1 per cent in total.
Hygiene has been the real catch through the crisis, though. Suddenly, the company senses opportunity. It provides products inside washrooms: soaps and hand sanitisers but also air sterilisers. Hygiene revenues rose 16 per cent year-on-year in the latest quarter. International expansion to mirror that in pest control could follow.
The company will have to be careful nonetheless. Its share price has been rolling up. At a heady 40 times forecast earnings, Rentokil does not have much room for error.
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