Barclays and Lloyds merit multiple expansion, Morgan Stanley says

25th Jun 2015 15:31

European Banks are undervalued as their risk profile and cost of equity have fallen sharply, one of the world's largest brokers said on Thursday.Lenders' move to de-lever has seen their beta, the most widely accepted measure of an investment's riskiness in comparison to the wider market, "fall dramatically" over the last couple of years, Morgan Stanley's European strategy team said in a research note e-mailed to clients on Thursday afternoon.The [rolling one-year] beta for banks has retreated from as high as 2.4 to just 0.75 today, the broker said.In parallel, their cost of equity now stands at 9.4% versus 11.7% at the end of 2014.A beta of one is taken to mean an investment's level of risk is the same as that of the wider market, while a level above that threshold reflects greater risk.Therefore, looking at financial metrics such as return on equity or price-to-book multiples is misleading. When the report was drafted financial markets were discounting an average RoE of 9.7% - in line with the 10% estimated by the broker's own analysts - but due to the above that missed the potential for multiple expansion.Indeed, Morgan Stanley estimated price-to-book values of up to 40% above current levels might be justified.Depending on the underlying assumptions for the so-called 'equity risk premium' price to book values of even 60% above current levels were possible.While challenges remained, and with dividend policies set to be an important litmus test, a "bottom-up" analysis favoured those names in a position to increase/switch on dividends, geared to QE/Asset management and restructuring potential.As a result of all of the above Morgan Stanley said Barclays, ING, Intesa San Paolo, Lloyds, Henderson Group, Natixis and UBS were the analysts 'most preferred' stocks in the sector.