Approximately three months ago, I presented the case here for why Barclays (BCS) would soar. It did. Shareholder value has gone up by 39.5%, beating the S&P 500 by more than 3x. While I am confident about the company's long-term resiliency, I find that much of the value gap has since been closed. UBS (UBS), on the other hand, still has plenty of room for generating high risk-adjusted returns. It is up 15.8% for the year to date and, despite the "hold" rating on the Street, still has more to shine.
From a multiples perspective, UBS is significantly the cheaper of the two. It trades at a respective 3.4x and 8.2x past and forward earnings while Barclays trades at a respective 11x and 14.8x past and forward earnings. Even though Barclays offers a dividend yield at 2.5%, UBS is meaningfully safer due to it being 50% less volatile. Deutsche Bank (DB) trades between the two at 7x and 7.4x past and forward earnings. Accordingly, Barclays could have a challenging time justifying the premium, especially in the event of a double dip.
At the third quarter earnings call, UBS' management noted some favorable figures amidst a challenging quarter:
"Our overall invested asset base held up despite the effects of heavy foreign currency depreciation. This is in large measure thanks to strong market performance. We further strengthened our capital base and reported Tier I ratio of 16.7% notwithstanding having called the $1.5 billion hybrid capital instrument.
Our core Tier I capital is CHF29.6 billion at the end of September, representing 14.2% of risk weighted assets, as calculated on the Basel II basis.
Our annualized return on equity year-to-date is been 17.6%, well within the range of the medium term target we set last year".
The main reason why UBS is the ideal value play of the three specifically stems form its strong Tier 1 Common Ratio. As weak earnings in peers make it challenging to gain liquidity and de-risk, this is a major check in the plus column for UBS. Trading inventory is also highly liquid. Largely due to weak performance in the third quarter, analysts have set expectations low. With that said, fourth quarter results in investment banking were low for peers and I do not anticipate UBS being an exception.
Consensus estimates for UBS' EPS forecast that it will decline by 39% to $1.14 in 2011 and then grow by 23.7% and 17% more in the following two years. Assuming a multiple of 13x and a conservative 2012 EPS of $1.36, the rough intrinsic value of the stock is $17.68, implying 29.1% upside. If the multiple were to decline to 9x and 2012 EPS turns out to be 9.9% below consensus, the stock would fall by 16.6%.
As for Barclays: the company was recently downgraded by the S&P 500 from A-1+ to A-1. The European Banking Authority estimated the bank's deferred tax assets at 3.3B pounds. While some analysts have expressed that this will tarnish the company's brand, I respectfully do not believe this is a concern. In my view, the more tax havens, the merrier for the shareholders. What I am concerned about, however, is the company's lofty target for 13% ROE by 2013 when it is currently trending at 7%. Disappointing momentum in the top-line for the 2011 further challenge outlook. Asset quality recovery has been slowing, which mitigates the benefits from cost savings efforts.
Consensus estimates for Barclays' EPS forecast that it will decline by 13% to $1.61 in 2011 and then by 29.2% more in the following year. Assuming a multiple of 15x and a conservative 2012 EPS of $1.11, the rough intrinsic value of the stock is $16.65, implying 19.4% upside. If the multiple holds steady and 2012 EPS turns out to be 7.9% below consensus, the stock would fall by 17.2%. Accordingly, I believe that UBS has significantly stronger risk/reward.