Since the beginning of the year, Banco Bradesco (BBD) has relentlessly climbed higher and higher for a return of 13.7% thus far, beating the S&P 500 (SPY) by more than 900 basis points. While the Street rates shares a "buy," I continue to find an unattractive amount of risk and strongly prefer Citigroup (C).
From a multiples perspective, ironically, the strong company, Citigroup is the cheaper of the two. It trades at a respective 8.4x and 6.5x past and forward earnings while being 160% more volatile than the broader market. Bradesco, meanwhile, trades at a respective 6.9x and 10.6x past and forward earnings while being 70% more volatile than the broader market. On the other hand, Bradesco is considerably more leveraged with net debt of $93.1B at 1.3x market value. Citigroup actually has a net cash position of $176.7B, which is 2x market value.
At the third-quarter earnings call, Bradesco's management noted favorable trends:
Evolution this quarter comes from the growth in the net interest income, mainly due to the increase in the volume of operations. Higher fees income as a result of the expansion of the private base and the reduction in the provisions for loan losses as well as the impact from higher personnel expenses due to the collective bargaining agreement, and greater administrative expenses mainly as a result of organic growth. I'd like to point out that our earnings per share in the last 12 months recorded a large increase from R$2.19 to R$2.38.
[T]he efficiency ratio adjusted to risk, which improved by 130 basis points this quarter,… reflect[ed] lower delinquency and the consequent reduction in the provisions for loan losses.
The Brazilian president recently approved 30% of foreign capital participation. But Bradesco is still waiting on approval from the SEC, NYSE, Bacen, and CVM, which it estimates will take about two months. A negative FX impact and rising overhead costs are eating at margins at a time when investors are concerned about whether the aggressive branch expansion in the second half of 2011 will pay off. As for the insurance market: lower unemployment rates are giving rise to a consumeristic culture that will feed business and thereby benefit underlying demand.
Consensus estimates for Bradesco's EPS forecast that it will grow by 13.5% to $1.68 in 2011 and then by 6.5% and 8.9% more in the following two years. Assuming a multiple of 9x and a conservative 2012 EPS of $1.72, the rough intrinsic value of the stock is $15.48, implying 18.4% upside. This multiple would be at the absolute high-end of peers who have stronger fundamentals.
Citigroup may have had a poor close to the year with earnings up only 6% for the year as clients cut back on risk, but the company has done well to hedge against macro vulnerabilities. NIM rose by 7% sequentially while the Tier 1 Common Ratio gained slightly. With valuation below book value and strong opportunities to cut the cost base by $3B this year, Citigroup merits a higher rating than the weak "buy" on the Street.
Consensus estimates for Citigroup's EPS forecast that it will grow by 10.6% to $4.08 in 2012 and then by 15.7% and 9.5% more in the following two years. Assuming a multiple of 9x and a conservative 2012 EPS of $4.65, the rough intrinsic value of the stock is $41.85, implying 36.6% upside.