UBS Investment Research published a report entitled “US Research” on December 30, 2011. The report isn't publicly available, but we will summarize main points. In the report, UBS listed its top stock ideas for 2012. This list includes the most-preferred and the least-preferred stock ideas and in this article we will discuss the top picks in the financial sector.
Citigroup Inc. (C) is a financial services company. It has been given a buy rating by UBS and has been placed on its most-preferred list. Due to Citigroup’s substantial progress in building its capital, UBS believes that the company is in a good position to increase its dividends. Despite the economic slowdown, Citigroup is expected to capitalize on its long-run global demographic trends. The company has also disposed off its non-core assets. UBS is of the opinion that Citigroup will continue to see strong trends in credit and a relatively less-exposed residential mortgage business. Shares of Citigroup are currently trading at $28.5 and are expected to reach $43, indicating a potential upside of 51%. Bill Ackman had nearly $700 million in Citigroup at the end of September.
Ares Capital Corporation (ARCC) is a specialty finance company that provides integrated debt and equity financing solutions. UBS has placed it in the most-preferred stock list and has given it a buy rating. Ares has a diversified investment platform that will be able to take advantage of most economic environments. By issuing equity and fixed-rate term debt, the company engages in a counter cyclical strategy that is expected to give Ares wider spreads and benefits from the capital market’s volatility. Ares has a well-developed origination and syndication platform that enables it to selectively add assets with the best risk-adjusted returns, without a need for it to increase its loan portfolio. The company has a 10% dividend yield. Shares of Ares Capital are currently trading at $15.7 and are expected to reach a price target of $19 per share. Due to the company’s high quality investment portfolio and a wide liability structure, it is expected to trade at a premium valuation than its peers.
NASDAQ OMX Group, Inc. (NDAQ) provides trading, clearing, exchange technology, security listing, and public company services. It has been given a buy rating due to its well-diversified franchise that is trading at a large discount. There are a number of upcoming catalysts that include a defensive business mix, opportunities in the non-transaction business, robust free cash flow generation ability, and a potential to pay its first dividends. Shares of NASDAQ OMX Group are currently trading at $24.4 and are expected to reach a price target of $29 per share, indicating a potential upside of 19%. The company generated returns of around 4% in 2011.
MetLife (MET) provides insurance, annuities, and employee benefit programs. UBS has given the company a buy rating and has ranked it as a top pick for the Life Insurance sector. The company offers a relatively more defensive position than its peers due to a well-diversified business portfolio. UBS expects the company to see a return on equity of 12% in 2013. The company is expected to see improvement in underwriting, begin cost-saving initiatives, and see a possible capital management action by March 2012. MetLife has a strong excess capital position, with $4.5 billion worth of excess capital. UBS expects MetLife to be strongly positioned against any economic downturn while the company is in a good position for any accretive merger and acquisition deals. Shares of the company are currently trading at $32.9 and are expected to go north of $60, indicating a potential upside of 82%.
Allstate Corp. (ALL) engages in the personal property and casualty insurance business. UBS is of the opinion that the company has a beneficial risk/reward potential in the near term due to the existence of positive catalysts. Pricing and re-underwriting initiatives are expected to have an impact on profitability. Also, earnings per share are likely to be revised upward due to the relatively easy comparisons for auto insurance. Allstate is also repurchasing its shares at a significant discount to book value, resulting in an increase in book-value-per-share. Shares of the company are currently trading at $28 and are expected to reach a price target of $34 per share, indicating a potential upside of 21%. UBS expects Allstate to have a sustainable return on equity of 11%.
U.S. Bancorp (USB) provides various banking and financial services in the U.S. The company has been given a buy rating by UBS due to its low-risk business model, a low-cost structure, and a wide revenue stream. UBS expects the company to outperform its peers based on historical evidence. Low-risk resources have been a significant part of the company’s revenue and the company has the potential to bring 55% of its revenue to the bottom line, versus a group average of 40%. The Fed’s review of bank capital plans, due this year, is expected to act as a near-term catalyst. Shares of U.S. Bancorp are currently trading at $27.7 and are expected to reach a price target of $32. The company has a 10.8x price-to-earnings multiple and UBS expects tangible common book value to grow by 13% in 2012. Warren Buffett’s Berkshire Hathaway had more than $1.6 billion invested in USB at the end of September (see Warren Buffett’s top picks).
KeyCorp (KEY) provides various banking services. UBS has given the company a buy rating and nominated it as the top pick for the mid-cap regional bank sector. KeyCorp has significant excess capital relative to Basel III and it is one of the best capitalized banks in UBS’ coverage list. The company is currently 69% through its loss recognition phase, is managing its expenses well, and is in the starting phase of increasing the performance of its franchise. Shares of KeyCorp are currently trading at $8 and are expected to reach a price target of $10, indicating a potential upside of 25%. Total book value is expected to grow by more than 8% in 2012.
SL Green Realty Corp. (SLG) is a real estate investment trust. UBS has given the company a buy rating because the company is offering an attractive play on the Manhattan office market. A continuation of transaction activity in the New York office and a 4.5% to 5.5% yield range for prime office assets is expected to be a positive catalyst for the company. EBITDA is expected to expand further as the company becomes an opportunistic buyer of core office properties, Manhattan retail locations, and multifamily properties within New York City. Shares of the company are currently trading at $69.8 and are expected to reach a price target of $80 per share. The company is also trading at 6% of its implied cap rate and at a 23% discount to UBS’ forward net asset value estimate. Billionaire John Paulson had $48 million in SLG at the end of September (see John Paulson’s top picks).
Disclosure: I am long C.