A branch sign is seen at a branch of Lloyds TSB in London February 26, 2010.
The Source: Paul Harris, partner and portfolio manager at Avenue Investment Management in Toronto.
The Idea: Buy Lloyds Banking Group PLC ADRs .
Lloyds, a U.K. based retail and corporate bank, was one of the best performing in the world before the 2008 financial crisis, Mr. Harris said in an interview. When Scottish bank HBOS PLC ran into trouble that year, the government asked Lloyds to buy it. HBOS is the holding company for Bank of Scotland PLC.
Without the crisis, Lloyds would not have been allowed to buy a rival bank, Mr. Harris says. In essence, Lloyds is a restructuring story. When banks merge, costs are wrung out of the operation and the result, sooner or later, is a more profitable bank.
Indeed, Lloyds surprised market watchers recently by saying it will be profitable this year, a year before most analysts had expected.
Lloyds' return on equity before 2008 was 24 per cent, and Mr. Harris thinks it can easily return to a 15-per-cent ROE before long.
Mind you, the British government still owns a big interest in the bank, which it plans to sell over time. Mr. Harris says the government has experience selling such stakes in an orderly way.
"They're not going to blow up their own stake."
When Lloyds needed money, it went to the stock markets for it rather than borrowing more from the government, he notes. It raised $22-billion (U.S.).
The Potential Payoff: A big capital gain over the next year or two, Mr. Harris says. The stock is trading at about $4 (U.S.), roughly in line with book value. While it's likely to bounce around for the next little while, "we certainly see it going much higher."
And while Lloyds does not pay a dividend now, it has in the past and will again in the future when the bank begins making more money, he adds. Also, banks have taken huge loan-loss provisions, he notes. If the losses turn out to be smaller than expected, those provisions would go right back into earnings.
"It's one of the best-run retail franchises in Europe."
The Big Risk: The main risk facing the bank is that the U.K. economy languishes, dampening the bank's profit prospects, or the government decides to dump a big block of shares, he says.
Why Listen to Paul Harris? "We have consistently shown that we outperform over the long term with our returns," Mr. Harris says. Indeed, the Avenue Total Return Equity portfolio is up 4.4 per cent to March 31, compared with 2.7 per cent for its benchmark (which is several benchmarks blended to reflect the portfolio's holdings). It is up 36.2 per cent over the past year and 8.1 per cent over five years.