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Financial companies are rebounding, but their stocks are not. A rare opportunity to buy in on the cheap.
The financial industry is in far better shape than the stocks in the sector would lead you to believe. Financials are the worst-performing sector in the Standard & Poor's 500 index so far this year, with a decline of more than 20%, and losses of 40% or more in such notable stocks as Bank of America, Citigroup, Goldman Sachs and Morgan Stanley. The S&P 500 is off just 3%.
The stocks—major banks, regional banks and trust banks, as well as life insurers—look appealing, with many trading at or below tangible book value, a conservative measure of shareholder equity, and at single-digit price/earnings multiples. The stocks are even cheaper based on stated book value, which includes goodwill from acquisitions. Most stocks now discount permanently low returns -- an overly bearish scenario -- just as they reflected permanently high returns not so long ago. Dividends are often in the 2% to 3% range -- and probably heading higher.
Bullish investors are excited because it is unusual to find low valuations in the sector based on both book value and earnings. At the 2009 market low, financials were valued cheaply based on book value but many were losing money and needed to raise tens of billions of dollars of new capital.
"There is massive undervaluation across the spectrum," says Matthew Lindenbaum, a principal at Basswood Partners, a New York investment firm. "People have been running away from the group, and investors are underweighted in financials. You can put together a diversified portfolio of financials that should do well in three years. It may require a little patience." He points to Goldman (ticker: GS), Morgan Stanley (MS), State Street (STT) and Comerica (CMA).
Banks and other financial companies generally are producing healthy profits and building ample capital bases despite a long list of concerns, including a weak economy, slack lending, margin contraction, low interest rates, regulatory pressure, mortgage litigation, poor trading conditions, proprietary trading restrictions and European financial turmoil. (For a survey of bargains among European bank stocks, see European Trader.) But the current situation is a far cry from the one in late 2008 and 2009, when the industry was on a financial precipice.
JPMorgan Chase (JPM) was the first major bank to report third-quarter earnings. Its results, released Thursday, were decent in light of tough conditions. The bank earned $1.02 a share, a dime better than the consensus estimate, and about flat with the year-earlier period. Profits were bolstered by a noncash gain of 17 cents related to weakness in the bank's own debt and those of some its derivative counterparties -- a weird factor mandated by accounting rules. Without that, earnings would have disappointed. JPMorgan's shares fell 5% on the news, to under $32 at Thursday's close, a slight discount to tangible book. The bank was cautious on the outlook for the fourth quarter and 2012.
On the plus side, it bought back 3% of its shares in the quarter and bolstered already strong capital ratios. Most major banks report third-quarter results this week.
Many financials could appreciate by 50% by the end of next year, including giants JPMorgan, Citigroup, Morgan Stanley and Goldman Sachs; regional banks such as Comerica, Suntrust (STI) and Fifth Third Bancorp (FITB); trust banks State Street and Bank of New York (BK), and life insurers Prudential Financial (PRU) and MetLife (MET).
The knock on the group is that there are too many issues and head winds for the stocks to do well anytime soon. It is tough to assess the potential impact of a European financial crisis on big American banks, and investors recognize that despite higher capital ratios and talk by managements about their "fortress balance sheets," banks are highly leveraged and depend on the confidence of lenders and depositors.
"No catalyst" is the familiar investor refrain. Yet the financial sector is up 13% from its Oct. 3 low, and could extend those gains if profit reports in the next few weeks reassure investors and Europe avoids a financial crisis. "If the economy does reasonably well, and you see some loan growth and higher interest rates, there could be a stampede back into these stocks," Lindenbaum says.
THE WIDELY FOLLOWED KBW BANK INDEX is off 28% so far this year and trades for about a third of its 2007 peak. All of the 24 stocks in the index are in the red this year. At the October low, the index was down 40% from its February high.
"There are a lot of questions about Europe and the regulatory and legal environment, but we believe banks can manage through them," says Jason Goldberg, banking analyst at Barclays Capital. "Most banks will have higher third-quarter earnings than a year ago, with higher loan balances, higher tangible book value, record capital and deposits and improving credit quality. It's a much different backdrop than a few years ago."
Major U.S. banks are in better shape than their European counterparts, many of which may have to sell stock to bolster capital, reduce the size of their balance sheets or jettison divisions. "The shrinking of European banks could be an opportunity for big U.S. banks," says John McDonald, the banking analyst at Sanford Bernstein.
U.S. banks could make further inroads internationally or acquire businesses that might be sold by European institutions. Many think Switzerland's UBS might consider a sale of its U.S. retail brokerage operations, which consists mainly of the old PaineWebber.
Investors also can buy a range of bank-related exchange-traded funds, including the SPDR KBW Bank ETF (KBE), which tracks the BKX index; the SPDR KBW Regional Banking ETF (KRE); and the broader Financial Select Sector SPDR (XLF), which tracks all financial stocks in the S&P 500. The trio yields around 2%. Two ETFs with triple leverage to the XLF are Direxion Daily Financial Bull 3X (FAS) and Direxion Daily Financial Bear 3X (FAZ).
Banks have replaced energy companies as the most hated industry in Washington. "Occupy Wall Street" activists have camped out in New York for about four weeks, and there have been protests in other cities against what a supporter and former New York Times reporter has called "the lords of finance," a group "impervious to human suffering, bloated from unchecked greed and privilege." While this may be a fringe group, there is broad populist anger directed at banks, stemming in part from the perception that the U.S. bailed out big banks -- and their richly paid employees -- while ordinary Americans were left to fend for themselves.
Just look at the storm caused by Bank of America's recent proposal to charge checking-account customers a $5 monthly fee for using debit cards, after Congress mandated sharp cuts in fees paid to banks on debit-card transactions -- which turned out to be a boon to merchants, not consumers. Banking services are unappreciated by many politicians and consumers, who seem to think they should be provided free despite the expense required to offer nationwide ATMs, transaction networks, branches and electronic banking.
THE BIGGEST BANKS have some of the lowest valuations and some of the biggest challenges. Bank of America, at $6 and change, and Citigroup, at below $28, trade for less than 60% of tangible book value and for under six times projected 2012 profit estimates. JPMorgan trades for six times 2012 profits. Reflecting its higher returns, Wells Fargo (WFC) is the most expensive stock in the quartet, trading for $26, or 1.5 times tangible book and eight times projected '12 profits. The bank reports earnings Monday and could deliver a positive surprise.
A new problem for the big banks seems to surface every month. There was the so-called Durbin Rule, cutting debit-card fees, proposed international standards that would impose a higher capital burden for the largest banks, litigation over trillions of dollars of mortgages originated by big banks before the 2008 financial crisis, and just recently the so-called Volcker Rule, which will limit banks' proprietary trading.
Much could be said about any one of these topics; Bernstein's McDonald wrote a 33-page report on mortgage litigation titled "Analyzing the Un-Analyzable." His view is that large U.S. banks should be able handle these claims with "existing reserves, earnings and capital." Bank of America, the most heavily targeted bank for litigation, already has realized losses or set aside reserves of more than $30 billion for legacy mortgage exposure.
McDonald is partial to several of the big banks, including JPMorgan and Citigroup. "JPMorgan has spent the last two years building out its franchise," McDonald says. It has expanded its retail banking presence, bolstered private banking and asset management, and pushed into the high-end credit-card market. McDonald has an Outperform rating and a $46 price target.
Citigroup seems too cheap, trading at a fraction of its June 30 tangible book value of $48. Investors seem to have recognized that, as the stock has rallied 20% from its Oct. 3 low of $23. Many hedge funds have bought Citi and sold short Bank of America, figuring that the two stocks have similar valuations and that Citi is in better shape.
Citigroup has the industry's best international retail and corporate-banking franchise and less exposure to mortgage litigation than any of the other major U.S. banks. McDonald believes Citigroup is capable of generating $5 a share in annual profits, a moderate 10% return on tangible book. The market now seems to be pricing in just half that profit level. Analysts expect Citigroup to earn almost $4 a share this year and $4.70 in 2012. McDonald has a $45 price target on the stock.
Since the start of this year, the perception of Goldman has changed radically. It has gone from "the smartest guys in the room" to a potentially "broken business model." The stock is now around $96, down from a January high of $175. Highlighting its woes, Goldman is expected to report a slight loss in the third quarter due to weak trading conditions. The firm reports results on Tuesday.
MORE THAN ANY OTHER MAJOR financial company, Goldman depends on trading profits, which together with investments account for two-thirds of revenue. Goldman is most vulnerable to the proposed Volcker Rule's curbs on proprietary trading. Goldman, which regularly generated a 20%-plus return on tangible equity, is on course to produce sub-10% returns this year. The big question is future returns.
Vastly diminished expectations are reflected in its stock, now trading at 80% of June 30 tangible book of $120 a share, marking one of the few times since the firm's 1999 initial public offering that it has traded below tangible book. While Goldman's profit outlook is hazy, it probably is capable of a 10% return on tangible equity, meaning $12-plus a share in earnings power.
That could mean a stock price of around $130 within a year if it merely gets back to trading near tangible book. The stock looks inexpensive on a sum-of-the-parts basis, given that its asset-management arm, with $844 billion in assets, could be worth $15 billion or $20 billion, a big chunk of Goldman's $54 billion market value. It is unlikely that Goldman will break apart, but the overcapitalized firm might start to return cash aggressively to shareholders if trading opportunities permanently diminish.
Goldman pays its people well -- an average of $428,000 last year -- but it has done a better job than its peers in cutting its ratio of compensation to revenue. Goldman's ratio was 39% last year, below a historic ratio close to 50%, and it may be on course for 40% this year. Barron's has argued in the past that the ratio ought to drop 35%, in line with the asset-management industry, because shareholders deserve a greater chunk of profits in a low-return world. The longtime argument that high compensation is needed to retain key employees might not wash. Where can high-earning but disaffected employees of Goldman and other investment banks go now, with industry opportunities limited, and Wall Street pay vastly exceeding that of any other industry?
Regional banks have suffered about as much as their large-cap peers this year. Bulls like Bernstein analyst Kevin St. Pierre think the group looks attractive with an average price/tangible book ratio near one. Most big regionals are profitable and their capital ratios are strong, with tangible common equity above that of their large-cap peers. "Despite no direct exposure to Europe, no trading [operations], low mortgage-litigation risk and lower capital buffers, regional banks have not performed like relative safe havens," St. Pierre wrote recently in a client note.
He highlights several stocks trading near or below tangible book, including KeyCorp (KEY), Comerica, Suntrust and Fifth Third.
Trust banks like State Street, Bank of New York and Northern Trust (NTRS) used to command some of highest price/earnings ratios in the banking sector because of high growth, high returns and high barriers to entry. The stocks have fallen from favor in recent years and have been crunched in 2011, hurt by weak markets, near-zero short-term interest rates and lawsuits stemming from alleged gouging of pension funds and big institutional clients on foreign-exchange transactions.
Bank of New York, at under $19, and State Street, around $33, now trade for less than 10 times estimated 2011 profits. They still have attractive franchises with high returns and steady institutional clients who rely on the banks for a range of custodial and transaction services. Low short rates have depressed several sources of their income, making the trust banks among the biggest beneficiaries of an eventual increase in rates.
LIFE INSURERS ALSO have been stung by the unexpected drop in long-term rates and weak stock market this year. They have giant investment portfolios that support a range of life-insurance policies, and low rates pressure margins because insurers are forced to reinvest principal from maturing bonds at lower returns. Tough equity markets also expose them to risks on variable annuities that often carry minimum surrender values.
"The stocks have more than taken these factors into account," says insurance analyst Jay Gelb at Barclays Capital. He favors MetLife, at $31, and Prudential, around $50, both now trading below book value and for about six times next year's estimate profits. Both get about half their profits from outside the U.S., mostly Asia, where markets are less competitive and returns are higher than here. Gelb argues that life insurers look good relative to property and casualty stocks, which now fetch higher P/Es. Historically, life companies have traded at higher multiples because of better returns.
Financial stocks have started to recover from one of their steepest falls ever. Expect that trend to continue, as banks and insurers prove more resilient and profitable than investors now expect. |
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狗仔卡
发表于 2011-10-15 04:58 PM
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发表于 2011-10-18 09:18 AM
