Bank of America Merrill Lynch resumes coverage of Credit Suisse Group AG (ADR) (NYSE:CS) with a new PO of CHF17: Including cash dividends, this gives total returns of >35%, on BAML's estimates. Trading at 0.8x NAV for 2019e RoNAV of >9% and 8.0x 2019e EPS, the firm rates CS a Buy, preferring it to Underperform-rated Deutsche Bank where it calculates -13% downside. On these multiples, CS shares are trading at a 20% discount to the sector vs an in line post-crisis average, which BAML thinks is unwarranted. The firm views CS as a rerating story: it expects it to deliver improving reported earnings through lower litigation charges, a smaller drag from non-core units and better underlying earnings. In the firm's view, operational leverage is vital to capture the benefit of advisor headcount and capital increases in wealth divisions and BAML takes comfort in the progress delivered in a strong 1Q17.
Capital is now at a good level (>13% RWA and >3.8% leverage) and on the current CET1/leverage constraint, Credit Suisse has moved ahead of its Swiss peer, UBS, for the first time. The firm expects CS to be well above the 10% minimum CET1 ratio even after a fully-loaded Basel 4, with scope to boost ratios further in the event of mitigating actions. In 1Q17 bank delivered the operational leverage BAML estimated with group revenues up CHF1.0bn and costs down CHF0.2bn.
In BAML's view, Credit Suisse needs to show that 1Q17 is the start of a turnaround in reported earnings and in organic capital ratio and balance sheet growth, which may take time. The firm's new forecasts show significant earnings recovery and are 9% ahead of consensus. However, BAML's forecasts are also 20% below management targets and imply significant upside potential if management were to succeed. The firm notes upside risk from the medium/long-term dividend story could crystallise once Basel 4 effects are known, making it even more compelling for longer term investors.