Investment bank Keefe Bruyette & Woods released their first quarter bank preview report to clients April 5. In the report, the research team led by analyst Brian Kleinhanzl upgraded Citigroup and Wells Fargo to “Outperform” from “Market Perform.”
Kleinhanzl is raising his price target on Citi to $US69 from $US56, because he believes that rising rates, deregulation, and share repurchases will lead to higher rates of return for the bank.
Additionally, KBW thinks that the departure of Fed Governor Daniel Tarullo will be a tailwind. Tarullo headed up Dodd-Frank regulation implementation at the Fed, and was focused on banking regulation. “We have grown more confident that Citi will be able to return capital at a higher level due to regulatory changes post -election (e.g., Fed Governor Tarullo leaving),” the note said.
For years Citi has had a very modest valuation, thought by some to be a value trap. Although Citi’s valuation is low, KBW does not believe that is the case.
“Citi currently trades at 9.8 times our 2018 estimate and 0.9 2x tangible book value , both steep discounts to peers (Exhibit 3),” KBW notes. “Part of the discount is due to lower returns, but as returns increase then we believe the discount should dissipate and provide investors an opportunity to find deep value in a sector that has seen valuation increase meaningfully in the last nine months.”
On Wells Fargo, Kleinhanzl is raising his price target on the California-based bank to $US63 from $US53.
During the last several months, KBW has valued Wells Fargo with a significant discount due to the negative sentiment surrounding the bank following the accounts scandal” at retail Wells Fargo locations. KBW is raising their price target because it thinks that Wells has moved passed the point where the scandal impacts earnings and the stock.
“We increased the required rate of return after the cross-sell scandal started, but we now believe required returns should be lower after WFC settled the class action lawsuits and several key metrics within the customer retail data have inflected positively,” Kleinhanzl wrote. “Thus, the clouds of uncertainty have parted from our view.”
Wells has traditionally traded at a multiple premium compared to other mainstream banks, but they lost that premium as a result of the fallout from the accounts scandal.
Kleinhanzl believes that Wells will get their premium back, and that now is the time to buy Wells if you want to get it at a discount.