Deutsche Bank is recommending a value play on battered bank stocks such as Wachovia (WB), National City (NCC), and Comerica (CMA), which the firm believes are undervalued and trading at historic lows compared to their franchise values. Using a proprietary method of valuation (uh oh) called the “Deutsche Bank Franchise Value Model,” DB tries to identify cheap bank stocks and potential takeover targets by valuing “hidden book” value:
BFV identifies takeover targets, relative valuation opportunities, and rich and cheap stocks by comparing stock prices to franchise values. We define franchise value as book value plus “hidden book” value, equal to unrecognised valuefor overfunded pension plans, asset management, core deposits, and other off‐balance sheet items.
With earnings distorted by market turmoil, DB’s BFV model tries to identify value plays by discounting unreasonable premiums on non-organic segments and purchased assets like deposits and credit cards:
While not an ending point for analysis, BFV helps to stress test scenarios such as loan losses, and therefore help quantify aninvestment margin of safety. In addition, franchise value is relevant during the era of bank consolidation. If a stock trades well below franchise value, it is possible that the bank will betaken over, the stock will appreciate in expectation of a takeover, or management will takesome action, such as restructuring, that helps the stock price.
DB thinks that, on this basis, Wachovia (WB), National City (NCC), and Comerica (CMA) are cheap and potential takeover targets. In fact, the banking industry in general are trading at relative lows, and may be attractive value plays:
The ratio of stock price to franchise value has ranged from a low of 80% (early 1990s) to a high of 200% around a consolidation peak (1997‐1998). The current ratio is 100%, reflecting a below average valuation for the first time in adecade which, in turn, has prompted us to upgrade some of the more attractive BFV stocks. The risk, however, is that we are too early in using an approach such as this, especially if the assumptions for loan losses are not enough, or if companies continue to dilute book value(and franchise value) with new equity issuances. Nevertheless, we feel that there is cushion for errors in some of the recent upgrades.
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