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Brazilian Banks
A More Challenging Environment Ahead - Reducing
Earnings Estimates and Adopting More Selective
Stock-Picking Stance; Bradesco to Neutral from OW
Banks
Saul MartinezAC
(1-212) 622-3602
saul.martinez@jpmorgan.com
J.P. Morgan Securities Inc.
Frederic Rozeira de Mariz *
(5511) 3048 3398
frederic.de.mariz@jpmorgan.com
Banco J.P. Morgan S.A.
Marcelo Motta
(55 11) 3048-6712
marcelo.g.motta@jpmorgan.com
Banco J.P. Morgan S.A.
* Registered/qualified as a research analyst under NYSE/NASD rules
See page 26 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision. Customers of J.P. Morgan in the United States can receive independent, third-party research on the company or companies
covered in this report, at no cost to them, where such research is available. Customers can access this independent research at
www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.
In this report, we formalize the more negative view on the Brazilian banks’ earnings
and profitability outlooks established in our recent report on the asset-quality cycles
in Brazil (please see “Brazil Banks: The Cycle Is Turning – What We Can Learn from
Recent Asset-Quality Cycles,” published on January 15, 2009). We are also adopting
a more selective approach to stock selection by downgrading Bradesco to a Neutral
rating from an Overweight rating and maintaining Itau as our sole Overweight rated
large bank stock in Brazil that is not in the process of being acquired.
• Reducing earnings and profitability forecasts to reflect higher credit
provisioning levels. For the large Brazilian banks in our coverage universe (Itau-
Unibanco, Bradesco, Banco do Brasil, and Unibanco), we are lowering our 2009
and 2010 recurring earnings estimates by 3-16%, primarily to incorporate greater
than previously expected asset-quality deterioration. Moreover, after normalizing
for the expected earnings accretion from pending transactions (e.g., Itau’s
acquisition of Unibanco, Banco do Brasil’s acquisitions of Banco Nossa Caixa and
Banco Votorantim), our 2009 recurring earnings estimates represent a decline in
earnings of 2-6% versus 2008. We expect recurring ROEs to fall 200-300 basis
points and amount to 19-20%, on average, for the aforementioned banks. Excluding
Banco do Brasil, our 2009 recurring EPS estimates are 6-11% below consensus.
• Asset-quality weakness is major concern. Our forecasts now incorporate roughly
100- to 150-basis-point increases in the nonperforming loan (NPL) ratios and 30-
50% increases in credit provisions for the large banks in 2009. As noted in past
research, in our view worsening asset quality is a much more meaningful concern
than possible net interest margin compression on the back of a falling Selic (a fear
we think might be overplayed). We see downside risk to our asset-quality estimates.
• 4Q08 earnings season kicks off on Monday. Bradesco releases quarterly results
before the market opens on Monday, February 2. In this report, we provide an
overview of our expectations for 4Q08 results, detail where we are versus consensus,
and, perhaps most importantly, provide a discussion of potential key forecast drivers
for each bank. In our view, this is a challenging quarter to forecast given numerous
company-specific events that could impact the results. Nonetheless, in our view, we
see some risk that subpar trading results and/or meaningful charges to shore up
balance sheets for potential asset-quality weakness (as Banco do Brasil recently
announced) could adversely impact the quarterly results.
• Downgrading Bradesco to Neutral; Itau remains sole Overweight-rated stock
among Brazilian banks not being acquired. While our valuation analysis suggests
good medium-term values, we are adopting a more selective stance toward stock
picking due to our more cautious stance toward earnings and profitability. As noted
in past research, we believe that having independent profit drivers will be critically
important to sustain solid profitability levels. Here, Itau stands out given potential
operating efficiency improvements resulting from cost synergies derived from its
merger with Unibanco. Ultimately, we believe that Itau deserves to trade at a greater
premium to Bradesco (currently 2.0x book value and 9.3x 09E earnings versus 1.9x
book value and 9.0x 09E earnings at Bradesco) given our view that profitability is
likely to be higher in the medium term at Itau.
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