Lloyds : Digital investments and dividend distribution

[dropcap]W[/dropcap]e believe concerns about the potential impacts of accelerated digital investments on dividends are misplaced. In our view, they are based on a misconception of banking where finance concepts developed for the analysis of non-financial companies do not apply, or apply differently. Hence, although we acknowledge it is hard to believe, for people not accustomed with monetary issues, in the banking world, contrary to the real economy, investments have no impact on cash flows and, consequently, on dividend distribution capacity. Some investors have started to worry about the potential implications of accelerated digital investments on dividend distribution capacity in spite of the group’s confidence in future excess capital generation (seen at an enviable 170- 200bp per year) signalled by its decision to perform a £1bn share buy-back. LLOY, like most banks, announced accelerated investments notably in digital. Hence, the group intends to invest £3bn over the next three years, a 40% increase versus what it spent during the former 2015-17 plan. If LLOY was a non-financial company, it is true that such an increase in investment spending would mechanically weigh on cash flows thus reducing the dividend distribution capacity. On the contrary, the following amortisation of investments would have no impact on cash flows and, consequently, on dividend distribution. However, LLOY is a deposit bank, and that changes everything. Indeed, its monetary institution status confers on it the unique power to create money, meaning that, whatever the type of investments (lending, acquisition of securities or property assets, investments in IT), the latter have no impact on cash flows and, consequently, on dividend distribution capacity. All things being equal, digital investments translate into increased capitalised costs on the asset side and an equivalent increase in deposits on the liability side with, consequently, no impact on the cash or equity positions. On the contrary, this is the amortisation of investments, which impacts the equity position, which consequently weighs on cash flows. However, IT investments (notably in digital), are supposed (this is the reason why they are capitalised) to translate into reduced operating expenses and higher revenues (digital customers are said to be more active). This is the reason why banks’ managements do not expect cost bases to inflate driven by digital investments. We stick to management’s view that LLOY will remain a cash machine. We reiterate our positive stance on the stock as we believe its above average value creation power is not properly reflected in the valuation.