Large broker dealers with exposure to capital markets had a strong performance heading into the New Year with the group’s share prices improving by about 10%. Lazard Ltd (NYSE:LAZ) was the top performer within Citi Research’s universe, as investors start to price in a merger and acquisition (M&A) recovery in 2014. Citi analysts, led by Keith Horowitz, updated their cost of equity assumptions, which reflect a 1.5% risk free rate, a 7.5% equity premium, and betas more in line to pre-crisis levels. One year trailing betas, in Citi’s view, are inflated and they may return to pre-crisis levels. Regarding earnings estimates, Citi remained neutral on Goldman Sachs Group Inc (NYSE:GS), Morgan Stanley (NYSE:MS) and Lazard Ltd (NYSE:LAZ).
Citi estimates that large banks and brokers in its coverage universe had a 9% year over year dip in fixed income revenues. Fixed income derivatives got a boost in 4Q13 due to a European Central Bank (ECB) rate cut. US fixed income derivative activity was weak on October 2013 but picked up at the end of the quarter due to tapering. Spread tightening also helped increase credit derivative volume at year end.
In contrast, Citi estimates a 3% year over year increase in equity trading revenues. Global cash equity trading improved during 4Q13 underpinned by overall equity market gains and improvement in initial public offerings (IPOs). Equity derivative trading moved at a healthy pace as clients proceeded to protect against volatility, particularly in Asian markets. Keith Horowitz and his team believe that the pickup in equity market and IPOs may bolster more M&A activity in 2014. Furthermore, Citi analysts believe that 2013’s strong IPO activity will likely support equity capital market activity as banks and broker dealers process follow on issues for firms previously engaged in IPOs.
Target prices for 2016 brokers
Goldman Sachs best positioned for equity capital market profits
Citi maintained its Neutral rating on Goldman Sachs Group Inc (NYSE:GS) as it believes markets are already pricing in the firm’s ability to generate returns above its cost of capital. Goldman Sachs Group Inc (NYSE:GS)’s target share price is $195 for 2016 pricing in a 12% return. Compensation expenses are expected to remain flat for 2013.
Goldman Sachs Group Inc (NYSE:GS) reports earnings tomorrow and Citi analysts expect $4.37 EPS for 4Q13 versus consensus estimate of $4.12. Upside on primary and secondary equity issuance activity may bolster results. Fixed income activity, in contrast, may come in as expected for 2013 as weaker commodity and mortgage trading were a drag on revenues. Dilution in EPS due to Warren Buffett’s exercising of warrants to purchase Goldman Sachs Group Inc (NYSE:GS) stock will probably be offset by 4Q13 earnings growth, in Citi’s view.
Morgan Stanley improving global wealth management margins
Citi maintained its Neutral rating on Morgan Stanley (NYSE:MS) as it suggests that markets are already pricing in the positive impact of improving revenues in global wealth management. Tailwinds for wealth management revenues include rising equity markets and investment banking activity. Rising equities helped bolster asset under management fees and investment banking activity helped in bringing in new clients. Citi analysts raised Morgan Stanley (NYSE:MS)’s target share price for 2016 to $35 using a lower cost of capital assumption.
Morgan Stanley (NYSE:MS) reports earnings on January 17, and Citi analysts expect $0.47 EPS for 4Q13 roughly in line with consensus estimate of $0.44. Citi analysts expect investment banking revenue to be down 35% year over year, partly due to a high watermark established during 2012. Equity capital markets and wealth management revenues will likely offset weakness in investment banking.
Lazard is expensive, in Citi’s view
Lazard Ltd (NYSE:LAZ) reports on February 3, and Citi analysts expect 4Q13 EPS to come out at $0.50 versus consensus’ estimate of $0.59. Even though Lazard grew its M&A and strategic advising market share, declining volumes relative to 2012 adversely impacted earnings. Improvement in asset management fees bolstered Lazard Ltd (NYSE:LAZ)’s results as equity markets rallied in 2013. In Citi’s view, however, the asset management boost has already been priced into the stock price. Citi values Lazard Ltd (NYSE:LAZ) at $46/share in 2016 implying a 4% return, the lowest in its coverage list.