Earlier this month, Tesco (LSE: TSCO) confirmed that it would be selling its mortgage book to Lloyds Banking Group (LSE: LLOY) in a deal worth £3.8bn. Tesco said it would be selling its mortgages thanks to “challenging market conditions” – a cover-all phrase that in this case means aggressive competition in the market driving down prices and profits.
Lloyds is expected to pay a 2.5% premium for the loans compared to their book value, and the move will see the transfer of some 25,000 customers from Tesco Bank to Lloyds’ subsidiary Halifax. Looking at the deal, it seems that both firms may be set to benefit.
Even paying a premium, Lloyds is able to make money from the loans as in effect, their terms are better than what could currently be issued in today’s low interest rate environment. Tesco Bank, meanwhile, said it would be using the proceeds of the sale to reinvest in its business and to reduce financing costs. Not glamorous perhaps, but useful.
This loan sale of course, while likely to benefit both companies, is only one small aspect of what the future may hold for their respective shares. Let’s consider some others.
Lloyds Banking Group
Of far greater importance for Lloyds, is the ongoing payment protection insurance scandal that this month, once again, came to the fore. The bank, along with rival Barclays, was forced to announce billions of pounds in extra charges on the back of PPI after a deluge of last-minute claims before the August cut-off deadline.
Lloyds said it’s setting aside an additional £1.8bn to cover its bill, taking its total for the scandal to about £22bn. What’s worse for investors, the costs forced the bank to suspend its planed share buyback programme for the rest of the year. Though it hasn’t announced any intention to, there’s an argument to be made that it may also have to cut dividend payments.
I think the stock may have lower to go before I’ll be looking to invest.
For the supermarket giant, the problems may be different, but may ultimately mean the same thing. Though any and all firms seem to use Brexit as an excuse for poor profits, Tesco and its peers have legitimate concerns around importing food from the EU post-Brexit.
Of even greater concern though, is competition. Recently rival firm Aldi announced that it will be investing £1bn to open new stores in the UK – averaging one a week for two years. Apparently the problem of not being able to shop if there isn’t a store close, has led the company to attempt to have a shop near to every person in the UK. If it succeeds, it could cause problems for Tesco.
As with Lloyds, these factors may not exactly be set to destroy the shares, but I think in Tesco’s case, the plan may not reap the benefits the company expects – at least not immediately. For now, I would avoid investing in either firm.
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Karl has no positions in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group and Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019