Better buy: Lloyds Banking Group plc vs Aldermore Group plc

Shares in Aldermore Group (LSE: ALD) gained as much as 5% after the challenger bank released its first-half results this morning. The business and mortgage lender said it had made "continued strategic and financial progress" during the period, helped by strong demand for new loans from UK businesses, homeowners and landlords.

Impressive growth

Aldermore, which only started trading in 2009, is certainly showing impressive growth in its balance sheet. In the six months to 30 June, its loan book grew by 8% to £8.1bn, as new loan originations gained 10% on the same period last year, to £1.6bn. This brings it closer to meeting its targeted growth range of 10%-15% for its year-end loan book.

As a result, profit before tax rose 32% to £78m, while basic earnings per share grew by 45% to 14.9p.

Aldermore also said its loan losses this year would be at the lower end of medium-term guidance of between 25-35 basis points due to benign credit conditions, reflecting the group's prudent underwriting standards and continued resilience in the UK labour market.

Value play

At its current share price of 228p, Aldermore still trades at just 7.5 times its expected earnings this year, with City analysts projecting bottom-line growth of 21% in 2017. That makes the stock seem to me like an attractive value play, but I also think it's worth considering some of the limitations of this business.

While it looks set to grow robustly in the near term, its longer-term prospects seem more uncertain. I have doubts about whether Aldermore's business model can sustain double-digit earnings growth as the economy slows.

I fear its over-reliance on mortgage lending, which currently accounts for more than three-quarters of its loan book, and worry about waning momentum in the UK housing market, which would likely put pressure on earnings growth going forward.

Although I think Aldermore is a well-run bank with a profitable and efficient operating model, I reckon there may be safer growth and income opportunities elsewhere.

Lloyds

Its much bigger rival Lloyds Banking Group(LSE: LLOY) seems to me like a better pick. It has less relative exposure to the more risky buy-to-let mortgage market, and as a mainstream lender, it has a more diversified loan book, which reduces its credit risk.

Having said that, Lloyds' recent growth has been slower, with underlying profits in the first half up by a less impressive growth rate of 8%, to £4.5bn. The bank also booked another £1bn provision for conduct charges in the second quarter, primarily in respect of PPI.

However, with the PPI deadline looming, it looks set to grow its already strong capital generation. With a common equity tier 1 (CET1) ratio of 14%, Lloyds has a robust balance sheet, which means any surplus capital should lead to growing dividend payouts for shareholders.

Combined with steady earnings growth, City analysts reckon shares in Lloyds are set to yield 5.8% this year, rising to 6.5% in 2018. The bank also trades at a forward P/E of 9.1, as underlying earnings is forecast to grow 8% this year.

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Jack Tang has a position in Lloyds Banking Group plc. The Motley Fool UK has recommended Lloyds Banking Group. 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.

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