Big Bank Stocks Have Plenty of Upside for 2014, Says Jefferies

NEW YORK ( TheStreet) -- Investors may be wondering whether or not to consider buying stocks in the largest U.S. banks, considering the sector's world-beating performance over the past two years, but stocks of the biggest banks are still relatively cheap, and the group is "levered to both domestic and international economic recovery and expansion," according to Jefferies analyst Ken Usdin.

When TheStreet last Friday looked at year-end bank stock valuations relative to consensus 2015 earnings estimates for all U.S. bank stocks, using data provided by Thomson Reuters Bank Insight, Bank of America ( BAC) had the ninth lowest forward price-to-earnings ratio, with JPMorgan Chase ( JPM) and Citigroup ( C) among the five cheapest banking names on this basis.

Here's a quick summary of performance and valuations for these three banks:

  • Shares of Bank of America closed at $16.50 Tuesday.  The shares have already risen 6% during the new year, following a 34.5% return last year and a 110% return during 2012.  The shares trade for 1.2 times their reported Sept. 30 tangible book value of $13.62, and for 10.4 times the consensus 2015 earnings estimate of $1.59 a share, among analysts polled by Thomson Reuters.  The consensus 2014 EPS estimate is $1.32.
  • JPMorgan closed at $58.32 Tuesday.  The shares returned 37% during 2013, following a 36% return during 2012.  The shares trade for 1.5 times their reported Sept. 30 tangible book value of $39.51, and for 9.2 times the consensus 2015 EPS estimate of $6.35.  The consensus 2014 EPS estimate is $5.99.  Based on a quarterly payout of 38 cents, the shares have a 2.61% dividend yield.
  • Citigroup on Tuesday closed at $54.22.  The shares are up 4% for the new year, after returning 32% during 2013 and 51% during 2012.  The shares trade just below their reported Sept. 30 tangible book value of $54.22, and for 9.2 times the consensus 2015 EPS estimate of $5.92.  The consensus 2014 EPS estimate is $5.30.
Usdin on Wednesday initiated his firm's coverage of Bank of America, JPMorgan and Citigroup. 

Bank of America

Usdin rates Bank of America a "buy," with a price target of $19, implying 15% upside for the shares over the next 12 months.  The company's "aggressive stance" in setting aside reserves for mortgage repurchase demands from investors has "put significant risks behind," according to the analyst.  With major lawsuits from American International Group and the Federal Housing Finance Agency (the regulator of Fannie Mae ( FNMA) and Freddie Mac ( FMCC)), Usdin forecasts another $6 billion in litigation expenses during 2014 and 2015.

The Federal Reserve's annual stress tests for the largest financial companies, followed by reviews of the companies' plans for the deployment of excess capital, has placed a major regulatory burden on the big banks, but has also turned late March into "the gift getting season" for investors.  Following last year's stress tests, Bank of America left its quarterly dividend at a penny a share, but received the Fed's approval for up to $5.0 billion i common-share buybacks and $5.5 billion in repurchases of preferred stock, through the first quarter of 2014.  Usdin expects $5 billion to $6 billion in repurchases of common shares from the second quarter of 2014 through the first quarter of 2015, along with an increase in the dividend to 5 cents a share during the second quarter.  "Regulatory capital accretion should continue at a rapid clip as the bank utilizes deferred tax assets (DTAs), making it likely that BAC's capital payout could accelerate in '15," he wrote.

Usdin's price target for Bank of America is based on a multiple of 11.5 times his 2015 EPS estimate of $1.65.  He is also ahead of the consensus with a 2014 EPS estimate of $1.35.

"Over the past few years, BAC has made significant strides to de-risk the balance sheet, fortify capital levels, reduce costs, and improve earnings visibility. It has carved a clear path to future earnings growth, efficiency improvement, and improving returns," Usdin wrote.

JPMorgan Chase

JPMorgan Chase has had a regulatory target on its back for years.  The "London Whale" hedge trading losses of more than $6 billion during 2012 raised the level of scrutiny on the company, although it didn't keep JPMorgan from setting another earnings record that year.  Earnings for 2013 will certainly be lower, as the company surprised investors with a third-quarter net loss, driven by $9.15 billion in provisions for litigation reserves.  JPMorgan began the fourth quarter with $23 billion in litigation reserves, which more than covered the company's $17.5 billion in mortgage-related settlements with the Justice Department, other government authorities and institutional investors. 

But when the company on Tuesday agreed to settlements costing $2.6 billion for its role in the Bernie Madoff Ponzi scheme, JPM announced that the settlements would lower its fourth-quarter earnings by roughly $850 million.

Heading into 2014, "Litigation/regulatory risks remain, but JPM closed out big legal items in 4Q, a spark for sentiment that could lead to further rerating," Usdin wrote.  By this he means that investors may reward JPMorgan with a higher multiple for its stock, considering that the company has been a solid operating earnings performer, especially for such a large bank.

Usdin rates JPMorgan Chase a "buy," with a price target of $66, implying 13% upside over the next 12 months. 

"Lower default servicing costs, lower litigation expense, seasoning growth initiatives, asset sensitivity, and share buybacks provide a path for earnings growth to the mid-$7 range in a 'normalized' environment," Usdin added.  That "normalized" environment will include an eventual increase in the short-term federal funds rate, which the Federal Open Market Committee has kept locked in a range of zero to 0.25% since late 2008.  Long-term interest rates have been rising, but most banks need to see short term rates rise as well, to drive a significant increase in their net interest margins. 

Jefferies expects JPMorgan Chase to announce a modest dividend increase to 44 cents from 38 cents following the stress tests, along with $5 billion in common-share buybacks from the second quarter of 2014 through the first quarter of 2015.

Usdin's price target for JPMorgan is $66, or a 10.5 multiple to his 2015 EPS estimate of $6.30.  His 2014 EPS estimate for JPM is $5.98.

Citigroup

Usdin assigned a "hold" rating to Citigroup, with a price target of $60, implying 11% upside over the next 12 months.  This stands in contrast to Oppenheimer analyst Chris Kotowski's "outperform" rating for the company, which on Monday he called "the last great bargain in financial services."

"Citigroup has simplified and de-risked its business model, with an incremental focus on operating efficiency as Citi demonstrates gradual progress toward '15 financial targets. We see a path toward the low-end of Citigroup's ROA target range for '15 (90bp-110bp), which seems to be lower than the current consensus view. A lower trajectory for fixed income trading fees, a slower pace of buybacks, and some incremental preferred dividends are likely the items that put us below consensus for '14/'15," Usdin wrote.

The analyst's price target for Citi is based on a multiple of 10.5 ties his 2015 EPS estimate of $5.70.  Usdin's 2014 EPS estimate for Citigroup is $5.15.

Usdin agrees that the capital tied up in the company's deferred tax asset valuation allowance and in the runoff subsidiary Citi Holdings make Citigroup "a top excess capital story in bank land," but also cautions that "investors must be patient," as it will take several years for excess capital to be deployed.

Usdin expects Citigroup to raise its quarterly dividend to 20 cents from the current nominal dividend of a penny a share, following the stress tests, and for the company also to announce approval for $5 billion in share buybacks through the first quarter of 2015.

Five-year Chart

Stocks of the largest U.S. banks have staged a major recovery over the past two years.  Going back five years, the returns tell a slightly different story.  JPMorgan has beaten the performance of the KBW Bank Index (I:BKX) and the S&P 500 , while Bank of America has lagged the indices and Citigroup's long-term shareholders are still "deep in the red," reflecting both companies' much less impressive overall earnings performance, as well as their dilutive common-share offerings: 

BAC Chart data by YCharts

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



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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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