Goldman Downgrades Citi, Calls USB 'Conviction Buy'

NEW YORK ( TheStreet) -- It's time for investors to be more selective in their large-cap bank stock picks, according to Goldman Sachs analyst Richard Ramsden.

The KBW Bank Index ( I:BKX) has risen 30% this year, following a 30% increase during 2012.  The largest U.S. banks have as a group fared even better, bringing forward price-to-earnings valuations "back in line with history," Ramsden wrote in a note to clients on Wednesday.

The analyst cut his rating for Citigroup ( C) to "neutral" from "buy," while upgrading U.S. Bancorp ( USB) of Minneaopolis to a "buy" rating from a "neutral" rating.  Ramsden also added USB to Goldman's "Conviction List," with a $44 price target, writing that the bank has underperformed over the past year, "as revenue growth has lagged from a deceleration of [commercial and industrial, or] C&I loan growth and slowing payments volume (part consumer, part government)."

Looking ahead, Goldman Sachs expects all of those trends that have placed a drag on U.S. Bancorp's shares "to reverse during 2014," as companies increase capital expenditures, the elevated savings rate declines and government spending increases.  Ramsden expects U.S. Bancorp  "to recapture its premium P/E multiple (particularly vs. regional peers), as relative valuation has historically correlated well with relative top-line growth," and for the company to fare particularly well in the 2014 round of Federal Reserve stress tests in March, with its dividend yield increasing to 2.7%.

U.S. Bancorp's shares closed at $38.52 Tuesday, returning 23% this year.  Based on a quarterly payout of 23 cents, the shares have a dividend yield of 2.39%.  The shares trade for 2.9 times tangible book value, according to Thomson Reuters Bank Insight, and for 12.0 times the consensus 2014 earnings estimate of $3.20 a share.  The consensus 2015 EPS estimate is $3.46.

U.S. Bancorp has been the strongest earner among large-cap U.S. banks for many years.  The company's return on tangible common equity (ROTCE) for the first three quarters of 2013 was a very strong 24.18%, according to Thomson Reuters Bank Insight.  The company's ROTCE for the three previous years increased steadily from 18.36% in 2010 to 22.28% in 2012.  The company's price-to-tangible book ratio reflects a considerable premium to the "big four" U.S. banks, reflecting USB's outperformance, however, the forward P/E ratio reflects a small premium:

  • Shares of Citigroup closed at $52.13 Tuesday.  The shares have returned 32% this year and trade for 0.9 times tangible book value, and for 9.6 times the consensus 2014 EPS estimate of $5.41.  The consensus 2015 EPS estimate is $5.95.  The company's ROTCE for the first three quarters of 2013 was 8.95% and its ROTCE ranged from 4.80% to 8.04% over the previous three years. 
  • Bank of America (BAC) closed at $15.54 Tuesday. The shares have returned 34% this year and trade for 1.2 times tangible book value, and for 11.6 times the consensus 2014 EPS estimate of $1.34.  The consensus 2015 EPS estimate is $1.60.  The company's ROTCE for the first three quarters of 2013 was 7.44%, and its ROTCE ranged from a negative 1.75% (in 2010) to a positive 2.96% over the previous three years.
  • Wells Fargo (WFC) closed at $43.73 Tuesday. The shares have returned 32% this year and trade for 1.9 times tangible book value, and for 10.9 times the consensus 2014 EPS estimate of $4.01.  The consensus 2015 EPS estimate is $4.23.  The company's ROTCE for the first three quarters of 2013 was 17.86%, and its ROTCE ranged from 14.77% to 16.70% over the previous three years.
  • JPMorgan Chase JPM closed at $56.86 Tuesday. The shares have returned 33% this year and trade for 1.5 times tangible book value, and for 9.5 times the consensus 2014 EPS estimate of $6.01.  The consensus 2015 EPS estimate is $6.36.  The company's ROTCE for the first three quarters of 2013 was 11.59% (reflecting its third-quarter loss), and its ROTCE ranged from 14.72% to 15.26% over the previous three years.
Ramsden has neutral ratings for Bank of America and Wells Fargo, while rating JPMorgan Chase a "buy," with a $65, as the company "has the most inexpensive valuation in the group on 2014, 2015 or "normal" EPS despite a leading ROTCE, meaningful leverage to a pick-up in capital market revenue, no execution risk around an announced cost-cutting plan and significantly reduced legal overhang."

He downgraded Citigroup despite the company's progress in improving efficiency and reducing the drag on earnings of its Citi Holdings runoff subsidiary, because of the stock's significant recovery.  With "less 'low hanging fruit' to improve returns from here, we believe current valuation more accurately reflects Citi's core earnings power," he wrote.

The following chart shows the year-to-date performance of Citigroup and U.S. Bancorp shares relative to the KBW Bank Index.

C Chart
data by YCharts

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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