Is Jamie getting nervous?
We downgrade GS from OW to N today. Our downgrade is driven by considering it has reached our Target Price of $175, offering the lowest upside within our Global IB universe. Even the theme of capital re-leveraging is discounted now in our view with the share price upside potential limited at a re-leveraged PE of 9.0x assuming $15.2bn buyback (17% of market cap) in 2012E, as discussed in Table 7 below. The Basel 3 Tier I ratio would be reduced to 9.9% from 12.1% in 2012; in-line with our JPM required capital methodology.
In addition, our regulatory arbitrage analysis illustrates that within US IBs, GS will be materially affected. We are convinced that GS will adjust to the challenges put forward in respect to regulatory changes in the Dodd-Frank bill, however even so overall earnings impact will be material as discussed in our note, “Global Investment Banks: Regulatory Proposal Analysis: Structural IB Profitability Decline”, published 09th September, 2009.
But before Goldman goes ahead and downgrades JPM, here is the silver lining:
We note, our downgrade is purely valuation related. Overall, it is difficult to argue against GS business model today and employee talent pool. Since covering GS we are highly impressed in terms of management talent. However, putting outperformance, current valuation, Dodd-Frank Act regulations and regulatory arbitrage headwinds into the valuation context and in addition, the theme of capital re-leveraging now being discounted, we conclude GS starts to be less attractive against global IB peers and is a relative N. Our US IB preference is now for MS over GS.
Is the pro-government banking cartel (MS, JPM) starting to side against the last "independent" banks? JPM's sudden love for the administration's most favorite bank certainly is curious:
MS – top US pick purely on valuation, but management needs to create value Our top US IB is now MS. This is purely a valuation call. So far we have been unimpressed with the MS turnaround - within the US the slowest compared to Citi and Bank of America undergoing material management and business restructurings. The IB strategy expansion so far has been unsuccessful, especially in Fixed Income whereas Citi and Bank of America are 'back in business'. However, considering its capital strength at 9.7% Basel 3 Tier I and valuation position at just 0.9x diluted tangible BV 2012E ex DVA, with 19% of earnings from Wealth Management there is upside potential. In addition, unlike for GS, in our view the share buyback potential is not fully discounted yet at an unleveraged PE of 8.6x - however, the big question mark remains is MS more than a $3 EPS IB? In our view, there is potential upside gearing for MS even without management value creation to our 2012E EPS of $3.05 fully diluted, as we believe material valuation will be unlocked in the long term through its high equity gearings.