FIN724/824 The Stock Market
Company Recommendation
Marsel J. Tadger
Kyle M. Ward-Dahl
Ke Wang
Adam J. Wilson
3/2/2010
1
Size and Composition of Financial Sector
• Market Cap: 1.6 Trillion
• 16.00% of S&P 500
• Industries
–
–
–
–
–
–
Banks
Consumer Finance
Diverse Financial Service
Insurance
Multi-sector Holdings
Real Estate Investment Trust
3/2/2010
Largest Companies (Market Cap in Billions)
• American Express (AXP)
$44.8
• Bank of American (BAC)
$150.8
• Berkshire Hathaway (BRK) $234.6
• Citigroup (C)
$93.8
• Goldman Sachs (GS)
$76.5
• Bank of NY Mellon (BK)
$35
• JP Morgan Chase & Co (JPM) $153.4
• Morgan Stanley (MS)
$36.4
• U.S. Bancorp (USB)
$48
• Wells Fargo (WFC)
$145.3
2
Recap of Sector Presentation
• Increase 100 basis points for Financial Sector
• Sold 241 basis points for Berkshire Hathaway
– New underweight: 234 basis points
14.00%
•
•
•
•
Feb 28th S&P Value=16.00%
Feb 28th SIM Value=8.98%
Necessary SIM Value=13.66%
Additional needed=468 BP’s
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
Current
Value
3/2/2010
New Value
3
S&P Index and SIM Weights
20.00%
18.00%
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
S&P 500
SIM
4.00%
2.00%
0.00%
3/2/2010
4
Current Sector Setup
JPM – 172 bp
GS – 305 bp
TCB – 270 bp
HCBK – 152 bp
Total – 898 bp
Underweight to expected– 468 bp
3/2/2010
5
Recommendation
• Increase holdings of Goldman Sachs (GS)
• Increase holdings Hudson City Bancorp Inc.
(HCBK)
• SELL ALL TCF Financial Corp (TCB)
• BUY Progressive Corp. (PGR)
• Hold JP Morgan Chase & Co (JPM)
3/2/2010
6
Proposed Setup
• After Selling TCB
– Underweight to expected by 468+270=738
•
•
•
•
JPM – 164 bp (stays the same)
GS – 493 bp (increased by 188bp)
HCBK – 452 bp (increased by 300 bp)
PGR – 250 bp (New Stock)
3/2/2010
7
Recommendation 1: GS
•
•
•
•
•
•
Market Cap: $80.38 B
Outstanding diluted shares: 550.9 M
Stock Price: $158.75
Beta: 1.74
Market Consensus: $215
Lines of Businesses:
– Investment Banking
(10.62% of total sales)
– Trading and Principal Investments
(76.09% of total sales)
– Asset Management and Securities Services (13.29% of total sales)
• Competitors:
– JP Morgan Chase Co.
– Morgan Stanley
– Merrill Lynch (privately held by Bank of America)
3/2/2010
8
Historic Prices of GS
3/2/2010
9
Relative Performance of GS
3/2/2010
10
Sales of GS
• Sales
FY
2011
2010
2009
2008
2007
2006
2005
2004
Investment Banking
7,131
6,665
4,797
5,179
7,555
5,613
3,599
3,286
Trading & Principal
Investments
30,430 28,439 28,879
8,095
29,714 24,027 14,996 11,583
Asset Management
& Securities Services
5,585
4,672
4,731
Total
49,206 45,987 45,173 22,222 45,987 37,665 24,782 20,550
Consensus
EPS
Consensus
5,219
4,090
4,527
3,090
2,655
47,333 45,414 45,678
20.41
19.07
22.13
20.47
18.60
18.95
4.47
24.73
19.69
11.21
8.92
 Red numbers are forecast in Assignment 2
 Strong rebound in Trading and Principal Investments
3/2/2010
11
DCF of GS
13%
Terminal Discount Rate =
Year
Revenue
2009E
2010E
$45,173
$45,987
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
$49,206
$52,404
$55,549
$58,604
$61,534
$64,303
$66,875
$69,216
$71,292
1.8%
7.0%
6.5%
6.0%
5.5%
5.0%
4.5%
4.0%
3.5%
3.0%
$19,829
$16,898
$18,081
$19,256
$20,411
$21,534
$22,610
$23,628
$24,573
$25,433
$26,196
43.90%
36.74%
36.74%
36.74%
36.74%
36.74%
36.74%
36.74%
36.74%
36.74%
36.74%
$6,444
$5,491
$5,876
$6,258
$6,633
$6,998
$7,348
$7,679
$7,986
$8,265
$8,513
32.5%
32.5%
32.5%
32.5%
32.5%
32.5%
32.5%
32.5%
32.5%
32.5%
32.5%
$1,193
$898
$961
$1,023
$1,085
$1,144
$1,202
$1,256
$1,306
$1,352
$1,392
2.64%
1.95%
1.95%
1.95%
1.95%
1.95%
1.95%
1.95%
1.95%
1.95%
1.95%
$12,192
$10,508
$11,244
$11,975
$12,693
$13,391
$14,061
$14,694
$15,281
$15,816
$16,291
-13.81%
7.00%
6.50%
6.00%
5.50%
5.00%
4.50%
4.00%
3.50%
3.00%
$10,508
$11,244
$11,975
$12,693
$13,391
$14,061
$14,694
$15,281
$15,816
$16,291
-13.81%
7.00%
6.50%
6.00%
5.50%
5.00%
4.50%
4.00%
3.50%
3.00%
Current P/E
6.7
7.8
7.3
Terminal Value
167,795
Projected P/E
9.8
11.4
10.6
Free Cash Yield
9.71%
Current EV/EBITDA
14.7
17.3
16.1
Terminal P/E
10.3
Projected EV/EBITDA
16.6
19.5
18.2
Terminal EV/EBITDA
14.4
% Growth
Operating Income
Operating Margin
Taxes
Tax Rate
Preferred Stock Dividends
Net Income
% Growth
Free Cash Flow
$12,192
% Growth
NPV of Cash Flows
NPV of terminal value
70,269 59%
49,431 41%
Projected Equity Value
119,700 100%
Free Cash Flow Yield
14.88%
Shares Outstanding
550.9
Current Price
$149
Implied equity value/share
$217
Upside/(Downside) to DCF
46.1%
3/2/2010
2011E
3%
Terminal FCF Growth =
12
Valuation of GS
Relative to Industry
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
1.2
1.1
1.5
1.2
1.8
Low
0.05
0.13
0.8
0.3
0.5
Median
0.96
0.94
1.0
0.6
1.1
Current
0.05
0.82
1.0
0.8
0.6
Relative to S&P 500
High
Low
Median
Current
P/Trailing E
2.1
0.38
0.70
0.38
P/Forward E
1.4
0.52
0.72
0.56
P/B
1.1
0.4
0.7
0.6
P/S
2.1
0.5
1.1
1.5
P/CF
1.7
0.5
1.1
0.6
Absolute Valuation
High
Low
Median
Current
#Target Multiple
*Target E, S, B, etc/Share
Target Price
(F x G)
A.
P/Forward E
P/S
P/B
P/EBITDA
P/CF
B.
21.5
3.6
5.7
4.01
21.3
C.
8.0
0.4
0.7
0.52
3.9
D.
12.2
1.7
2.1
2.30
12.1
E.
8.0
1.7
1.3
3.09
5.7
F.
11
1.7
2
3.2
12
G.
$19.07
$89.77
$114.4
$48.13
$26.09
H.
$210
$153
$229
$155
$313
 Target price to buy: $213 (average of DCF and Valuation prices)
3/2/2010
13
Key Ratios of GS
3/2/2010
14
Catalysts of GS
• The increase of employees
FY
2009
2008
2007
2006
2005
2004
No. of Employees
36,200
30,067
30,522
26,467
22,425
20,722
• Global and emerging markets
–
–
–
–
Opened offices in Mumbai, Moscow, Sao Paulo, Dubai, Qatar, Riyadh and Tel Aviv
Became licensed broker-dealer in Russia, India and China
Opened banks in Brazil, Ireland and Russia
Entered asset management business in South Korea and India
• The recovery of economy and financial markets
3/2/2010
15
Risks of GS
• Uncertainties
– Real estate market
– Interest rates
• Lack of investors’ confidence
– Record high unemployment rate
• Regulations
– Liability tax bill (0.15%)
– Limitation of proprietary trading
– Prohibition of Private Equity business
3/2/2010
16
GDP Forecast
Nominal GDP (Expected)
$18,000
$17,000
$16,000
$15,000
Nominal GDP (Expected)
$14,000
$13,000
$12,000
2009
2010
2011
2012
2013
2014
% Change in GDP
5.0%
4.0%
3.0%
2.0%
1.0%
% Change in GDP
0.0%
-1.0%
-2.0%
-3.0%
2009
3/2/2010
2010
2011
2012
2013
2014
17
Interest Rate Forecast
• Federal Reserve is going to keep the current interest rate
• Interest rate rise is beneficial in the long term
3/2/2010
18
Quantify key risks or benefits
• Liability tax
– -$1.17 B, -$2.12 per share
• Prohibition of Private Equity Investment
– $14 B of PE holdings, 2% of $849 B total assets
– Probably spin-off if the bill is passed
• Limitation of Proprietary Trading
– Hard to determine the definition and size
– Probably not being passed
• Preferred Stock of Sumitomo
– Converted to Common Shares
– $1.1 B, not included in financial statements, $2 per share
 No material impact on Goldman Sachs
3/2/2010
19
Recommendation 2: PGR
• Mitigate risk
–
–
–
–
–
SIM has no insurance industry stock.
Hedge against Goldman Sachs
PGR = Auto Insurance
No mortgages, no hurricanes, no bailouts.
Focused strategy vs. nearly all competitors are vertically
integrated.
• Low cost
– Companies such as Nationwide and AllState are losing
customers to no-agent based player like Progressive.
3/2/2010
20
Progressive DCF
PGR (000)
Analyst: Marsel Tadger
Date: 02/23/2010
Year
2009E
Revenue
13,096,902
% Grow th
2.0%
Operating Income
1,801,600
Operating Margin
13.8%
Interest and Other
108,600
Interest % of Sales
0.8%
Taxes
510,500
Tax Rate
28.3%
Net Income
1,182,500
% Grow th
1.0%
Add Depreciation/Amort
417,500
% of Sales
Plus/(minus) Changes WC
% of Sales
Capex % of sales
2.0%
1,837,632
13.8%
110,772
0.8%
520,710
28.3%
1,206,150
2.0%
425,850
0.8%
531,124
28.3%
1,230,273
2.0%
434,367
28.3%
1,254,878
2.0%
443,054
0.8%
468,257
29.0%
1,146,423
-8.6%
462,543
12.0%
124,651
0.8%
486,988
29.0%
1,192,280
4.0%
481,045
6.0%
1,912,154
12.0%
132,130
0.8%
516,207
29.0%
1,263,817
6.0%
509,908
16,731,348
5.0%
2,007,762
12.0%
138,737
0.8%
542,017
29.0%
1,327,008
5.0%
535,403
17,567,916
18,446,311
5.0%
2,108,150
5.0%
2,213,557
12.0%
145,674
12.0%
152,958
0.8%
569,118
0.8%
597,574
29.0%
1,393,358
29.0%
1,463,026
5.0%
562,173
5.0%
590,282
19,184,164
4.0%
2,302,100
12.0%
159,076
0.8%
621,477
29.0%
1,521,547
4.0%
613,893
3.2%
(50,400)
(51,408)
(52,436)
(53,485)
(55,624)
(57,849)
(61,320)
(64,386)
(67,606)
(70,986)
(73,825)
-0.4%
139,026
1.0%
1,413,300
1,441,566
8,719,886
49%
51%
-0.4%
141,807
1.0%
1,470,397
2.0%
-0.4%
144,643
1.0%
1,499,805
2.0%
-0.4%
144,545
1.0%
1,408,797
-6.1%
-0.4%
150,327
1.0%
1,465,149
4.0%
-0.4%
159,346
1.0%
1,553,058
6.0%
-0.4%
167,313
1.0%
1,630,711
5.0%
-0.4%
175,679
-0.4%
184,463
1.0%
1,712,247
1.0%
1,797,859
5.0%
5.0%
-0.4%
191,842
1.0%
1,869,773
4.0%
Terminal Value 28,046,600
12.36%
Projected EV/EBITDA
541,747
119,857
1,803,919
15,934,617
2019E
3.2%
100%
Current EV/EBITDA
0.8%
12.0%
4.0%
2018E
3.2%
9,030,254
Projected P/E
115,247
1,734,537
15,032,658
2017E
3.2%
2.0%
Current P/E
13.8%
4.0%
2016E
3.2%
17,750,141
Free Cash Yield
9.7
9.5
9.3
15.0
14.7
14.4
7.8
7.7
7.5
8.5
8.3
8.2
6.67%
Terminal P/E
18.4
Terminal EV/EBITDA
10.0
672600
Shares Outstanding
Current Price
$
17.00
Implied equity value/share
$
26.39
55.2%
Debt
2,180,000
Cash
1,080,000
3/2/2010
112,987
1,911,872
14,454,479
2015E
3.2%
Projected Equity Value
Cash/share
13.8%
2.0%
2014E
3.2%
NPV of terminal value
Upside/(Downside) to DCF
1,874,385
13,898,537
2013E
3.2%
% Grow th
Free Cash Flow Yield
2.0%
2012E
3.2%
1.0%
NPV of Cash Flows
13,626,017
5.0%
3.2%
136,300
Free Cash Flow
13,358,840
2011E
12.0%
Terminal FCF Growth =
3.2%
-0.4%
Subtract Cap Ex
2010E
Terminal Discount Rate =
1.61
21
Correlation of GS and PGR
Correlation -.60
3/2/2010
22
Progressive has a strong correlation to auto sales (.79)
3/2/2010
23
Automotive sales are expected to increase significantly in next 5 years.
3/2/2010
24
Valuation of PGR
Relative to S&P
500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Low
Median
Current
34.2
2.4
1.5
1.3
6.5
.6
.65
.3
.4
.7
.8
.85
1.1
.9
1.1
.60
.81
1.0
.7
.8
Absolute
Valuation
High
Low
Median
Current
#Your
Target
Multiple
A.
P/Forward E
P/S
P/B
P/EBITDA
P/CF
B.
56.5
2.0
4.8
57.43
81.5
C.
8.6
.6
1.6
4.59
6.4
D.
14.1
1.4
3.2
9.07
12.8
E.
11.8
.8
2.1
5.71
8.2
F.
14.1
1.4
3.2
9
13
*Your
Target
E, S, B,
etc/Share
G.
1.45
21.44
8.17
3.00
2.09
Your
Target
Price
(F x G)
H.
20.49
30.01
26.13
27.03
27.19
Average = $26.17
3/2/2010
25
Recommendation 3: HCBK
• Add 300 basis points to Hudson City Bancorp
(HCBK)
• Remarkably safe bank-stock
• No exposure to commercial real estate
• Comparatively very low foreclosure risk
• High yield
Safe Bank Stock
• During the recent credit crunch, while
competitors were consolidating losses, HCBK
was able to grow its assets substantially
• Only fell ~50% from peak to trough, as
opposed to 90%+ for many of its competitors
• No risky investments (CDS, derivatives, foreign
assets etc)
No Commercial Real Estate
• HCBK has no exposure to any commercial real
estate risk
• Solely focused on consumer loans
• HCBK focuses on one distinct asset class
– High-value jumbo home loans
– Wealthy areas of New York, New Jersey, and
Connecticut
• Able to specialize in this asset class
Low Foreclosure Rate
• Low acceptance rate
– They finance only top value clients
– Most clients have the net worth that they could
finance the home with their own personal assets
• Very high down-payments
– 30% down payment is their most common variety
Example (Homes bought at peak in 2006)
HCBK
• 1 loan to high wealth
customer
• $1,000,000 home
• $300,000 down payment
• Loan value=$700,000
Competitor
• 5loans to unknown value
customers
• $200,000 homes
• $10,000 down payment per
house
• Loan values=$950,000
Housing Market Falls 35%
From Peak to Trough in 2009
HCBK
• Loan value=$700,000principal already paid
• Home value=$650,000
• Negative equity=~$25,000
– Average customer still has
plenty of net worth to ride
out the storm
Competitor
• Loan value=$950,000principal repaid
• Home values=$650,000
• Negative equity=~$250,000
– I think we know the result
here
Expanding Markets
• Looking to purchase a bank in Florida, where
many of its high-value customers have
summer homes
• Looking to expand its banking operations in
the New York Metro area, to further serve its
high-value customers
High Yield
• HCBK Yielding 4.44% as of 02/09
• HCBK has consistently and rapidly increased
its dividend since its IPO in 2000
– Company expects these increases to continues
DCF
Current Price
Implied Equity Value/Shr
Upside/(Downside) to DCF
13.30
24.54
84.5%
Terminal Discount Rate =
Terminal FCF Growth =
11.50%
4.00%
Multiples Valuation
Absolute
Valuation
High
Low
Median Current
A.
P/Forward E
P/S
P/B
P/EBITDA
P/CF
B.
31.6
19.4
5.7
15.46
33.5
C.
9.8
4.4
1.1
1.29
10.9
D.
19.8
12.9
1.8
10.16
24.1
E.
11.2
5.5
1.3
2.91
11.5
#Your
Target
Multiple
F.
18
12
1.75
6
20
*Your
Target
E, S, B,
etc/Shar
e
G.
1.18
2.41
10.21
4.56
1.15
Your
Target
Price
(F x G)
H.
21.24
28.92
17.87
27.36
23.00
Average=23.67
Q&A
3/2/2010
36