Financial Stocks Without the Big-Bank Worries
This week, all eyes will be on the financial stocks as one after another, the country’s biggest banks follow Wells Fargo (WFC) and release earnings for the fourth quarter of 2012. But rather than agonizing over the gargantuan penalty that Bank of America (BAC) will pay to settle its long-running dispute with Fannie Mae (large enough to put a big dent in estimated earnings growth not just for financial stocks but for the S&P 500 as a whole), why not take a look at some other financial stocks – the kind that don’t get nearly as much attention?
Brennan Hawkin, an analyst at UBS Investment Research, did stop to ponder the outlook for two boutique investment banks recently, and found them just as good as all but one of their bigger rivals. (The only one of the crop that he reviewed in his recent report on which he maintains a ‘buy’ rating is JP Morgan Chase (JPM)). But while he is sticking to a ‘neutral’ rating when it comes to Evercore Partners (EVR) and Greenhill & Co. (GHL), he boosted his estimates for both companies’ earnings for 2013 and into 2014, as well as forecasting that mergers and acquisitions advisory revenue will grow 24% at Greenhill and 23% at Evercore this year.
That’s far from shabby from two companies that often toil in the shadows of their larger rivals, despite having purer-play models, few if any legacy issues and less regulatory risk. There also is less balance sheet risk: these firms are intermediaries, underwriting financing packages but not putting their own capital on the line in the same way the Morgans (MS), Goldmans (GS) and Citigroups (NYSE:C) do. Both boutiques rely on deal making to generate profits, so returns can be more volatile, tied as they are to capital markets trends.
Greenhill’s returns on equity have been highest among the boutique investment banks --a group that also includes Lazard (LAZ), which Hawkin recommends selling -- and it also has seen the biggest gain in book value in the last year. Hawkin points to Evercore as being able to expand market share, even if its results are “mixed” in the near term.
Greenhill and Evercore also offer some of the most attractive dividend yields within the financial sector, possessing both the cash to pay out dividends without putting undue stress on their balance sheets, and the willingness to do so.
These boutiques have done a good job managing costs, so that the kind of large-scale layoffs just announced by Morgan Stanley aren’t likely to prove necessary. For instance, while third quarter revenues at Evercore declined slightly, the company still managed to beat earnings expectations, as expenses fell more than revenues. Meanwhile, analysts like Hawkin have been revising their earnings estimates higher in the weeks that have followed the release of the company’s third quarter results.
Perhaps the biggest question hovers over Lazard. Hawkin’s bearishness seems to stem from what he believes will prove to be a big fourth-quarter decline in deal volume. In contrast to that 23% or 24% growth on the part of the two other boutiques, Hawkin estimates that Lazard’s likely growth in M&A advisory revenues will be only 7% this year. But there’s also an argument to be made that Lazard’s asset management division – which generates the vast majority of its operating income – may be undervalued at the current share price of $33.75. Even if M&A deal activity remains underwhelming, that will provide a firm, if not spectacular, basis for growth in revenues and profits. Moreover, the company has made clear that it plans to trim back debt that is currently weighing on that growth at present.
So while all the buzz this week centers on what’s happening at Goldman Sachs or JPMorgan Chase, this might be a good opportunity that the world of financial stocks isn’t just confined to giant banks, but includes these niche players just waiting for an uptick in M&A activity to grab the spotlight.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.
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