Since I first wrote my bullish and controversial article on Barclays (BCS) here, the stock has taken off like a rocket, gaining 56.7% thus far. The Street now rates the firm around a "buy", according to T1 Banker, and I share this sentiment. Another financial to consider is UBS (UBS), which has done a stellar job to mitigate risk.
From a multiples perspective, UBS is by far the cheaper of the two. It trades at a respective 3.5x and 8.4x past and forward earnings, while Barclays trades at a respective 10.3x and 16.3x past and forward earnings. UBS may be less preferred on the Street, but this sets the bar low for high risk-adjusted returns when the macroeconomy picks up. Financials offer some of the most attractive value opportunities, given the unusually high degree of behavioral anomalies that surround the industry's trading activity. While financials may also carry plenty of risks, this fear discounts them significantly to, say, a "recovery scenario".
When it comes to Barclays, investors are chiefly concerned about the company's ability to manage costs, improve liquidity, and weather regulatory headwinds. At the 2011 earnings call, Barclays' management addressed some of these top concerns of investors:
"We delivered profits of GBP 5.6 billion for the year. The contribution from our businesses in Retail and Business Banking broadly balanced those of Corporate and Investment Banking, and revenues were well diversified geographically, demonstrating the strength and diversification of the universal banking model.
Importantly, our major businesses also improved their market share. While top line income was down 8% in a difficult environment, income grew in 5 of our 7 businesses and impairment improved 33%.
We controlled costs tightly so that we now have the confidence to double our cost reduction target for 2013 to GBP 2 billion. We reduced performance-related pay by 25%, while profits were down just 2%".
Fourth-quarter cost control was strong, with operating costs falling an impressive 5% sequentially. Accordingly, management doubled its 2015 cost-savings target. At the same time, the core T1 ratio of 11% improved confidence over liquidity, and I anticipate that it will improve by a 100 bps to 12% over the next 2.5 years. In addition to these improving metrics, Barclays also has a few strategic areas where it can unlock value: spurning underperforming / risky assets and reducing exposure to investment banking. Towards addressing the first issue, management has already downsized functions in Spain and the UK.
Consensus estimates for Barclay's EPS forecast that it will decline by 24.4% and 30.9% in the next two years. Assuming a multiple of 10x and a conservative 2013 EPS of $1.94, the rough intrinsic value of the stock is $19.40, implying 23.9% upside.
In terms of liquidity, UBS has the lead with a CT1 ratio (Basel III) trending towards 14% by 2013. The attention should now shift over to improving ROE through share repurchases. However, management has already been so successful in mitigating risks that competitors are starting to mimic the firm's actions. Operationally, the company needs to work on shifting more towards wealth management, since investment banking is likely to experience double-digit y-o-y declines.
Consensus estimates for UBS' EPS forecast that it will grow by 21.8% to $1.34 in 2012, and then by 17.9% and 10.8% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $1.35, the rough intrinsic value of the stock is $17.55, implying 22.7% upside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
