The Banking sector is expected to continue to face challenges during 1H2012 due to the slow economic recovery in the United States, and due to the slowdown in Europe. However, the latter part of the year may witness price appreciation in banking stocks, which are already trading at attractive valuations. Positive results from a very harsh stress test and continued economic recovery in the US will be the key determinants of this potential upside. On the other hand, political risks would remain elevated due to an election year.
The earnings for banks are expected to be driven by 1) a recovery in loan growth, 2) a slow but continuous improvement in credit costs, 3) a continuation of cost cutting efforts, and 4) benefits accruing from share repurchase programs undertaken by select banks. A few US banks may also benefit from the divestitures of U.S. assets by European banks, and this could result in growth across business lines. At the same time, pressure on net interest margins would keep earnings under stress. Although the M&A activities are likely to remain muted, continued slow economic recovery in the US may encourage some small bank deals.
Given the uncertainty that prevails in the economic environment, we suggest investors to focus on defensive and quality stocks. We currently pitch 3 stocks as the best Buy ideas for 2012. While we pitch 2 stocks with high risk tolerance as stocks with high potential upsides.
Citigroup Inc. (C) is a global, diversified financial services holding company. The company offers consumers, corporations, governments and institutions with a range of financial products and services. The group operates in two primary segments; namely, Citicorp, which consists of Regional Consumer Banking and the Institutional Clients Group, and Citi Holdings, which consists of Brokerage, Asset Management, Local Consumer Lending, and Special Asset Pool. The Group's operations span over 200 million customers and 160 countries. Citigroup has lately been beaten on account of concerns regarding the eurozone crisis with its bank having significant exposure to the eurozone. Eurozone concerns may not disappear very soon but growing revenues and profitability in Asia and the Latin America region may eventually over-ride this overplayed issue.
Despite the harsh stress test, Citigroup is expected to get approval for a share repurchase activity, which may lead to aggressive price appreciation in the stock during the latter part of 2012. The bank has one of the highest capital ratios among large-cap banks. Moreover, emerging markets are expected to recover relatively early which may add additional flavor to Citigroup's international portfolio. The stock trades extremely cheap on P/TBV and forward P/E ratios of 0.66 times and 7.0 times compared to a peer average of 1.41 times and 10.97 times respectively. However, the PEG ratio and dividend yield for the stock is on the lower side at 0.8 times and 0.95% compared to the peer average of 1.56 times and 2.4% respectively. On the basis of valuations and the company's balance sheet, we really like the stock, and pitch it aggressively as a Buy to investors.
Bank of America Corporation (BAC) is a bank holding and a financial holding company offering banking, investing, asset management and other financial and risk management products and services. The company operates through six business segments: Deposits, Global Card Services, Home Loans & Insurance, Global Commercial Banking, Global Banking & Markets and Global Wealth & Investment Management. The bank is trading cheap at current P/TBV and forward P/E ratios of 0.65 times and 7.63 times compared to a peer average of 1.41 times and 10.97 times respectively. Its PEG ratio and dividend yield stands at 1.28 times and 0.6% compared to the peer average of 1.56 times and 2.4% respectively.
We propose a Buy call on the stock primarily on the basis of extremely attractive valuations. Any significant recovery on the macro-economic front is likely to increase the interest of investors in the stock compared to other large-cap banks.
US Bancorp (USB) is a financial services holding company, providing a range of financial services, including lending and depository services, cash management, foreign exchange, and trust and investment management services. The bank also deals in credit card services, merchant and ATM processing, mortgage banking, insurance, brokerage and leasing. We like US Bancorp primarily on the basis of its comparatively low level of risk due to healthy capital and capital returns. An upside in the revenue growth for the bank exists on account of anticipated portfolio acquisitions and exploration of relatively new lines of businesses.
On the other hand, the stock is currently trading at a premium to its peers, which is justified given its balance sheet strength, an above average growth component and competitive dividend yield offered by the stock. The stock is currently trading at P/TBV and forward P/E ratios of 2.83 times and 9.96 times, compared to the peer average of 1.41 times and 10.97 times respectively. Tthe PEG ratio and dividend yield for the stock stands at 0.99 times and 2.4%, compared to the peer average of 1.56 times and 2.4% respectively. Hence, in our opinion, due to current valuations being at a premium, the stock may not deliver high capital gains. Nonetheless, on the back of our expectations regarding continued improvement in macro-economic fundamentals in the US, we pitch US Bancorp as a Buy.
Wells Fargo & Company (WFC) is a diversified financial services company which provides banking, insurance, investments, mortgage banking, investment banking, retail banking, brokerage, and consumer finance products and services. The Company operates in three segments, namely Community Banking, Wholesale Banking, and Wealth, Brokerage and Retirement Fund Management. We are impressed by the bank's performance. Wells Fargo remains adequately cushioned by quality capital and a high return on capital. The company is anticipated to drive its revenue growth through portfolio acquisitions and expansion in other businesses.
The stock is trading in line with its peers at P/TBV and forward P/E ratios of 1.7 times and 8.48 times, compared to a peer average of 1.41 times and 10.97 times respectively. The PEG ratio for the bank is quite low at 0.32 times, compared to the peer average of 1.56 times, while its dividend yield is competitive at 2.4% and in line with its peer average. Given that the stock's valuation is in line with its peers, while its balance sheet and profitability are above average, we believe it to be a good Buy at current levels. Hence, we suggest an overweight stance on the stock.
PNC Financial Services Group, Inc. (PNC) is a diversified financial services company, engaged in retail banking, corporate and institutional banking, asset management, and residential mortgage banking products and services within the US. The company also provides certain products and services internationally. In December 2011, PNC acquired the Georgia Retail Bank Franchise from Flagstar Bancorp, Inc. The company intends to keep growing its business and has recently sought approvals to expand its operations into Canada.
The stock trades slightly cheaper to its peers at P/TBV and forward P/E ratios of 1.42 times and 8.97 times, compared to the peer average of 1.41 times and 10.97 times respectively. The stock also appears attractive as per the PEG ratio and dividend yield which are both relatively on the higher side at 2.48 times and 2.59% as compared to the peer average of 1.56 times and 2.4% respectively. On the basis of relatively cheaper valuations, a higher growth and a better dividend yield offered by the stock, we recommend a Buy stance on the stock.