As the possibility of a double-dip wanes with each passing day and investors begin to appreciate limitations to Europe's decline, financials are starting to rally somewhat. Over the last twelve months, Goldman Sachs (GS), Citigroup (C), and Morgan Stanley (MS) were tightly correlated to one another and declined by roughly 45% in value. However, the last 3 months have seen a slight recovery in the last two. While analysts rate all of the companies around a weak "buy", I am more bullish. I find that - in agreement with consensus estimates - Citigroup is the most undervalued of the three. Below includes some of the latest information from analysts.
Goldman Sachs is the leading investment bank with key emerging market growth to hedge against domestic volatility. Admittedly, the firm is perhaps the most vulnerable to financial reforms, especially in the area where derivatives trading and leverage is concerned. With that said, the company has strong liquidity with a net cash position of $344B, 7.6x market value. Investor fears about the euro crisis have also been overblown, as GS has limited exposure to GIIPS Sov. Investment banking and asset management may have shrunk in size, but margins are trending upwards.
GS has a beta of 1.4 and trades at a respective 14.4x and 7.1x past and forward earnings while offering a dividend yield of 1.52%. Cash per share stands at $89.71. Consensus estimates for the firm's EPS are that it will decline by 56.9% to $5.68 in 2011 and then grow by 126.8% and 8.8% in the following two years. Of the 11 revisions to estimates, all have gone down for a net change of 7.8%. The target price is $135.83, which implies a 47.6% discount. Assuming a multiple of 9.5x and a conservative 2012 EPS estimate of $12.77, a safer estimate for the rough intrinsic value is $121.32, which implies 31.9% upside.
Citigroup has seen its asset quality and loan growth both improve. The latter has picked up since March and is normalizing around a growth rate of 5%. Fourth quarter results are likely to illustrate the success of commercial banking, but also the challenges in trading. Particularly attracting about the firm is Citi, which trades at only 0.6x tangible book value, despite having great growth opportunities and solid liquidity.
I find that of the three financials highlighted in this article, Citigroup is the most undervalued. Recently, a few activist shareholders have built up a position, including Bill Ackman of Pershing Square. Citigroup has a beta of 2.54 and trades at a respective 7.1x and 6x past and forward earnings while offering a dividend yield of 0.2%. Net cash stands at $135B, 1.8x market value, and cash per share is $9.90 - both of which are the lowest among the three. The company's target price is $42.65, which implies a 63.4%.
Consensus estimates for Citigroup's EPS are that it will grow by 1.6% to $4.08 and then by 7.1% and 14.9% more in the following two years. Of the 15 revisions to estimates, all have gone down. Assuming a multiple of 9x and a conservative 2012 EPS of $4.33, the rough intrinsic value of the stock is $38.97, which implies 49.3% upside. Only if the multiple were 6.5x and 2012 EPS turns out to be 6.9% below the consensus would the current market price be justified.
Morgan Stanley is yet another that has been overly discounted due to sovereign debt concerns. Not only is the firm hedged against Europe, the CDS curve is likely to ease and the Core Tier 1 ratio is anticipated to improve to 13.4 by 2012. The company recently settled with MBIA (MBI) for $1.1B. Overall this will reduce uncertainty and the anticipated decline in Tier 1 Common Ratio under Basel I will be offset by the anticipated growth in Tier 1 Common Ratio under Basel III - a 25 bps differential.
The firm has a beta of 1.5 and trades at a respective 8.8x and 7.3x past and forward earnings while offering a dividend yield of 1.3%. Cash per share is $6.34 and net cash stands at $237.7B, 8.3x market value. The target price is $22.94, which implies a 53.9% discount.
Consensus estimates for Morgan Stanley's EPS are that it will decline by 48.8% to $1.25 in 2011 and then grow by 62.4% and 18.7% in the following two years. Of the 15 revisions to estimates, 13 have gone down for a net change of -21.1%. Assuming a multiple of 9.5x and a conservative 2012 EPS of $1.98, the rough intrinsic value of the stock is $18.81, implying 26.2% upside.