3 Risky Financials With More Than 10% Upside

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 |  Includes: KEY, MS, NLY
by: Takeover Analyst

We take a closer look at a list of financials with more than 10% upside. The companies cover a variety of industries: REITs, investment services, and banks. Of the three companies on the list, I prefer KeyCorp the most due to its combination of low volatility and depressed multiples. I view all the firms as highly risky, given the macro-economic uncertainty and regulatory headwinds. While much of the risk has been factored into the stock prices, a double dip is still a very real concern. All ratings are sourced from T1 Banker.

Annaly Capital (NYSE:NLY)

Annaly is rated a "hold" and trades at a respective 5.8x and 6.7x past and forward earnings, with a dividend yield of 14.6%. Consensus estimates for Annaly's EPS forecast that it will fall by 24.1% to $1.95 in 2012, grow by 6.7% in 2013, and then fall by 6.3% in 2014. Assuming a multiple of 9x and a conservative 2013 EPS of $2.02, the rough intrinsic value of the stock is $18.18, implying 11.7% upside. I prefer Chimera (NYSE:CIM) over the firm due to its higher dividend yield and lower multiples (only trades at 6.7x forward earnings).

Annaly shareholders are enthused by a management team that is equipped with deep industry knowledge, but I believe this premium largely represents blind faith. As many bears have rightfully noted, management refuses - or struggles, anyway - to clarify its strategy and business model. Real estate is risky at the moment, and though the company will be a major beneficiary of low interest rates, the upside story has largely been accounted for. I recommend holding out for now and, at the very least, waiting for a pullback.

Morgan Stanley (NYSE:MS)

Morgan Stanley is rated a "hold" and trades at a respective 15x and 7.7x past and forward earnings, with a dividend yield of 1.1%. Consensus estimates for Morgan Stanley's EPS forecast that it will grow by 50.8% to $1.90 in 2012, and then by 24.2% and 17.8% in the following two years. Assuming a multiple of 9x and a conservative 2013 EPS of $2.31, the rough intrinsic value of the stock is $20.79, implying 14.2% upside.

The company had a weak start to 2011 with the loss of its Japanese joint venture. At the same time, the firm realized a 300 bps gain in share in Equities and meaningful penetration in Fixed Income. Even Investment Banking share grew 100 bps, which well positions the firm for a booming IPO market as the economy fully recovers. In addition, Morgan Stanley improved its balance sheet to reduce risks in 2011.

KeyCorp (NYSE:KEY)

KeyCorp is rated a "hold" and trades at a respective 8.7x and 9.9x past and forward earnings, with a dividend yield of 1.5%. Consensus estimates for KeyCorp's EPS forecast that it will decline by 12.6% to $0.76 in 2012, and then grow by 5.3% and 26.3% in the following two years. Assuming a multiple of 12x and a conservative 2013 EPS of $0.77, the rough intrinsic value of the stock is $9.24, implying 17.3% upside.

Management has meaningfully improved credit quality and has boosted the Tier-1 Common Ratio to above 10%. I expect the company to increase takeover activity, as competitors try to shore up cash. The company may also consider spinning off parts of its Community Bank business, which has been a drag on value creation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: The distributor of this research report is not a licensed investment adviser or broker-dealer. Investors are cautioned to perform their own due diligence. We seek business relationships with all of the firms in our coverage, but research covered in this note is independent.