Leading U.K. bank Lloyds TSB (NYSE: LYG ) is a "threefer" for U.S. investors. I'm submitting it as the Best International Stock for 2007 for a trio of key reasons:
- Dividends say a lot about a company's expectation of producing true free cash. Lloyds' 5.7% yield beats most blue chips hands-down.
- Lloyds is focused in the United Kingdom, which gives U.S. investors a hedge against further declines in the dollar. Since Jan. 1, 2003, the pound sterling has increased 18.7% against the U.S. dollar.
- The company is still undervalued and has opportunities to create more value for shareholders.
Since I recommended Lloyds to Motley Fool Inside Value subscribers just more than two years ago, the ADRs trading on the NYSE are up a healthy 35%, but total returns, which include dividends, are up more than 48%. For comparison, the SPDRs exchange-traded fund, which is based on the S&P 500 index and includes dividends, is up just less than 30% in the same time period.
The business of banking
Lloyds TSB has been in a turnaround mode for the past three years, under the very capable guidance of Citibank veteran Eric J. Daniels. Lloyds shed its international operations to focus its resources on its U.K. banking and insurance assets. The company is an aggregate of some very well-known U.K. financial brands, arising from the 1996 merger of TSB Group and Lloyds Bank Group.
Today, the company provides traditional retail and commercial banking through Lloyds TSB, major mortgage banking through Cheltenham & Gloucester, and insurance and investment services through Scottish Widows. All told, Lloyds serves more than 15 million U.K. retail customers, and excellent high-street and Internet distribution channels enable cross-selling across the brands. In its latest half-yearly results, the company reported steady 8% growth, with all of its reporting units -- U.K. Retail Banking, Insurance & Investments, and Wholesale & International Banking -- showing a consistent upward trajectory.
How much is it worth?
Lloyds believes that it is in the second stage of a three-part growth strategy. Even with pressure from competitors Barclays (NYSE: BCS ) and HSBC (NYSE: HBC ) , I'm confident that Lloyds can grow earnings in the 7% to 8% range over the next five years while continuing to pay a dividend that yields more than 5%.
The company has an excellent 24% return on equity, and management seems keener to return cash to shareholders than fritter it away on expensive acquisitions. I conservatively value the ADRs at $49 per share -- roughly 12% below today's prices. If this doesn't sound like much of a value, I believe there could be more upside to these shares. Despite its $60 billion market cap, the company has been the subject of several takeover rumors, notably from Citigroup (NYSE: C ) , acquisitive Spanish giant BancoSantander (NYSE: STD ) , and even Warren Buffett's Berkshire Hathaway (NYSE: BRK-B ) in the past two years. Based on other mergers and acquisitions in the U.K. market, I estimate that the takeout price to acquire Lloyds would land in the $52-to-$55-per-share region.
The Foolish bottom line
As attractive as the prospect of a near-term takeover might be, I do not want Lloyds to be acquired, nor would I invest based on that possibility. I think that the current management is exceptional, and that it will continue to grow the bottom line and return significant cash to shareholders. Lloyds might not be the girl you want to show off to your mates, but she's the right one to take home to your Mum -- and to put in your portfolio for secure market-beating returns.
Agree? Disagree? Head over to our new Motley Fool CAPS service and let us know whether you think Lloyds will outperform or underperform the S&P 500 going forward. Our CAPS community has been bullish on Lloyds up till now -- it's rated five stars out of five. Join CAPS today (it's free) to read what other investors are saying, and add your own bull or bear argument while you're there.
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Philip Durell is advisor/analyst ofMotley Fool Inside Value, the newsletter service dedicated to value investing. Lloyds and Berkshire Hathaway are Inside Value selections. Philip does not own shares of any company mentioned. The Fool has adisclosure policy.