Big Opportunity in Four Big Banks

December 22nd, 2009 by john

UGoldMine.CoM:

THE POOR RECEPTION FOR CITIGROUP’S BIG EQUITY offering last week and the sharp drop in the company’s share price capped what has been a rocky period for major banking stocks. But the outlook is brightening.

Now that the investment community has digested $50 billion of equity offerings from Citi (C), Bank of America (BAC) and Wells Fargo (WFC) to repay the government’s Troubled Asset Relief Program investment, shares of the big banks look attractive, with earnings set to rise significantly in coming years.

While Citigroup, Bank of America, JPMorgan (JPM) and Wells Fargo have different stories, they all look appealing, based on the “normalized earnings” they might earn, starting in 2012, and their stock-price/tangible-book-value ratios.

JPMorgan may have the clearest path to higher profits, the strongest management and one of the industry’s best business mixes. It has suffered far less equity dilution than any of the other major banks, and it has improved its franchise with the fire-sale purchases of Washington Mutual and Bear Stearns in the past year.

JPMorgan also could be one of the first major banks to boost its dividend in 2010. The money-center banks used to boast ample payouts, but their yields now range from zero to 0.8%. JPMorgan CEO Jamie Dimon said recently that the bank aims to increase its annual dividend to 75 cents to $1 a share in 2010, up from 20 cents now, and that it should go higher from there.

“JPMorgan offers the best mix of offense and defense,” says John McDonald, a banking analyst at Sanford Bernstein. “Its management has been able to focus…while other managements have been distracted.” JPMorgan, at 40, has been flat since the summer and could hit 57 in a year, McDonald says.

Investors are looking at banks based on projected 2011 profits and normalized profits starting in 2012. Wells Fargo, JPMorgan and Bank of America trade for under nine times projected 2011 profits and for about six times normalized earnings. Morgan’s normalized profits are an estimated $7 a share. Wells Fargo, now trading around $26, is seen producing normalized earnings of about $3.75. Bank of America, now around 15, could earn $2.75 in 2012. Put a price/earnings ratio of 10 times on normalized profits, and each of these three stocks could climb as much as 80% in the next two years.

Citigroup is the riskiest member of the Big Four, given its weaker near-term profit outlook and the challenge of its good-bank/bad-bank strategy of focusing on its desirable global consumer and commercial banking franchise and its investment bank, while divesting about $600 billion in assets. Citi, however, looks appealing, following a sharp drop of 65 cents in its shares last week, to $3.30, as Wall Street struggled to digest its $17 billion equity offering, Citi trades for a fraction of its estimated tangible book value of $4 and at 6.6 times potential normalized profits of 50 cents a share in 2012. The stock could top $5 in the next two years — a target that seems achievable because it traded at $5.25 in August.

THE HIGH-PROFILE EQUITY OFFERING was a disappointment — hurting the Street’s already fragile confidence in Citi’s management — as the bank was forced to sell stock at $3.15 late Wednesday, about 30 cents below the market quote that afternoon and worse than the expected price of $3.25 to $3.35. Given this, the government declined to sell any part of its $25 billion stake in a concurrent offering. The Treasury paid $3.25 a share for its 7.7 billion shares. The Treasury’s decision begot a vicious cycle; it made investors even less willing to buy because of the large overhang of stock still in Uncle Sam’s hands.

Bank of America trades at 1.3 times tangible book; JPMorgan, at 1.6 times; and Wells Fargo, at 1.8 times. These ratios are historically low and considerably below those of the Big Four Canadian banks. While those institutions benefit from an oligopolistic structure, the fragmented U.S. banking system is becoming more concentrated, with Bank of America, Wells Fargo and JPMorgan controlling about a third of the American deposit market. Wells has the highest price/book ratio among the four because it historically has generated one of the highest returns on equity among large banks.

Price-to-tangible book is a conservative valuation measure because the book value excludes goodwill from acquisitions and other intangible assets. Banks look even cheaper, based on stated book, which includes goodwill and other intangibles. JPMorgan trades for little more than its stated book value of $39 a share.

Another way to play the banks is through their preferred stock, which looks safer now that they’ve bolstered their common equity capital. Citi’s trust preferred, like its series W, now trades for 19 (below its face value of 25) and yields about 8.50%. Bank of America’s series J preferred trades around 22 for a yield of 8%, and Wells Fargo has a preferred issue, series L, with a $1,000 face value, now trading around 940 with a yield of almost 8%. JPMorgan preferred generally yields less than 7%.

Among the issues still dogging bank stocks are concerns about tougher regulatory and capital rules, as well as whether banks actually will hit normalized profits in 2012, given weak lending activity that is reducing the size of balance sheets.