This could be a big year for banking stocks.
With tax legislation passed, rate hikes expected and an M&A environment ever-changing, Nomura analysts rounded up the best and worst picks for the sector in 2018 in a Jan. 3 note.
"Heading into 2018, we are growing much more constructive on our coverage universe, as various policy tailwinds and economic drivers appear poised to meaningfully boost earnings, something we believe is not adequately reflected in shares," analysts wrote.
Tax reform will provide the most significant upside for earnings, Nomura noted, with about an 18% increase on average to 2019. Higher rates and excess capital stoking growth will become the two next-largest drivers of earnings for banks.
Higher rates in Nomura's view assume an accelerated pace of Fed hikes with four increases through 2019E. Excess capital and growth analysis assumes firms can return all excess capital in the form of additional buybacks or accelerated bank growth, Nomura said.
It's becoming an increasingly granular landscape in bank stocks, but Nomura sifted through to determine the best, the worst and the in-between.
While the sector at large will benefit, small- and mid-cap names and eBrokers are set to gain the most from tax reform, higher rates and deployment of excess capital, Nomura said. Their upside could top 20% moving into 2018 and beyond.
But for Nomura, it's all about self-help bank stocks.
"With no shortage of tax/rate winners in our coverage," Nomura said, "we see greater alpha potential in self-help candidates."
Nomura's top picks are LPL Financial Holdings Inc. (LPLA - Get Report) , E*Trade Financial Corp. (ETFC - Get Report) , Bank of America Corp. (BAC - Get Report) and Lazard Ltd. (LAZ - Get Report) , which will all benefit from policy changes including tax legislation and rates. But there is "more room for differentiation" beyond just that, including positive expense surprises, higher capital return and strategic alternatives.
Nomura additionally said it expects "tax clarity to reinvigorate large/cross-border deal activity" this year. That means a more robust M&A environment could return to Wall Street.
Analysts upgraded Stifel Financial Corp. (SF - Get Report) to "buy" as tax overhaul and a better M&A scene should "more than offset" MiFID and DCM pressures." A discounted valuation, too, supports about a 25% upside for shares. Lazard also got a new "buy" rating at Nomura, "given heavier gearing to mega-cap M&A, with possible C-corp. conversion (likely forthcoming), justifying >2-turns multiple expansion."
Nomura's least preferred are policy laggard Goldman Sachs Group Inc. (GS - Get Report) and valuation and earnings risk Greenhill & Co. Inc. (GHL - Get Report) . Analysts expect delayed earnings growth compared to peers from Goldman and a continued "show me" story from Greenhill.
Nomura added lowlights for 2018 -- analysts remain less positive on trading as secular headwinds hinder fee pools and Volcker relief offers only a "modest offset." Additionally, analysts added that, "on the tax side, we believe the discrepancy between domestic tax winners and global laggards is not fully appreciated, with tax guidance from universals likely to disappoint, notably [Goldman and Citigroup Inc. (C - Get Report) .]"
Analysts noted that Citi still retains "compelling long-term value," but optimism is contained by limited ability to capitalize on tax and rate tailwinds.
On the Fence
Nomura remains neutral on The Charles Schwab Corp. (SCHW - Get Report) and Evercore Inc. (EVR - Get Report) . For Schwab, some risk abated with tax reform, but there remains limited upside for shares trading below 20 times Nomura's 2019E forecast. Evercore stock could get a boost with M&A and tax changes, but MiFID headwinds and negative revision risks are thought to continue to hinder the firm into the beginning of 2018.
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