Itau Unibanco: Is ROE Meeting Cost Of Capital?

• The share price of Itau Unibanco Holding SA (ADR) ITUB has declined 41.56 percent year to date, hitting a low of $6.32 on September 28.
• Marcelo Telles of Credit Suisse has downgraded the rating on the company from Neutral to Underperform, while lowering the price target from R$37 to R$30.
• The downgrade is based on valuation, while Telles believes that the risk-reward profile of the stock has deteriorated, with “practically no upside” from the current levels.

According to the Credit Suisse report, “Despite the high-quality management team and the remarkable efficiency improvement efforts, the faster deterioration of the Brazilian economy has painted an even more challenging scenario compared to our last sector update six months ago, making the bank to barely meet its cost of equity next year.”

Analyst Marcelo Telles believes that there could be a lot of room for earnings disappointment, which would lead to the stock underperforming, going forward.
Itau Unibanco is expected to see significantly higher provisioning expenses as well as a higher effective tax rate, which Telles expects to more than offset the expected increase in NII during 2016 and 2017.

Telles also expects 2016 to be “another year of muted loan growth,” with a large part of the repricing already reflected in 2015. Moderate NII growth is expected in 2016, which along with the expected 26 percent growth in provision would lead to a 7 percent decline in pre-tax profit, along with a 14 percent decline in net profit.

“After extensive bottom-up and top-down analysis of asset quality, we came to the conclusion cost of risk should rise materially for the sector and consequently for Itau Unibanco,” Telles added.