Citigroup Analyst Cuts U.S. Brokerage Firms' Price Estimates

Lower client trading volumes are hurting operations at large U.S. brokers like Goldman Sachs Group Inc.(GS), Lehman Brothers Holdings Inc. (LEH) and Morgan Stanley (MS). They are also facing losses on hard-to-sell assets like mortgage securities. As a result, analysts like Citigroup’s Prashant Bhatia are cutting their estimates on the firms.

Mr. Bhatia cut his price target on Lehman from $50 to $35 per share to reflect his expectations for writedowns and lower forward estimates. He also hiked its risk rating to “speculative” as a result of lower confidence in the franchise seen in CDS spreads at near-peak levels.

In a note, the analyst said:

Having said that, once there is clarity around the plan to reduce illiquid assets, spreads will likely tighten again.

Lehman is expected to take asset-related writedowns of $2.9-billion in the third quarter, while Mr. Bhatia forecasts $1.8-billion at Goldman and $1.7-billion at Morgan Stanley.

He has a “buy” rating on Morgan Stanley given its good position to benefit from an improving environment and Lehman because it is discounting more erosion in book value than he anticipates. The Citigroup analyst added that Lehman should be able to take more than $3-billion in after-tax losses before needing to add more common equity.

Mr. Bhatia said:

While we still see compelling value in the franchise and little liquidity risk, the reality is that until there is more clarity around the cost of reducing its hard-to-sell asset exposure ($75b), Lehman will continue to trade at distressed levels. The good news is that there should be more clarity within the next few weeks, which in our view will result in more stability around the stock.

As for Morgan Stanley, he believes its core earnings power has been underestimated. Mr. Bhatia said:

Based on the franchise’s current ability to generate meaningful revenue growth, the CEO’s commitment to focus on accelerating revenue growth, and a cost base that has been burdened with regulatory and legal-related costs—in our view, it’s a matter of when, not if, the earnings power will meaningfully accelerate, resulting in enhanced shareholder value.