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Citigroup's stock price should double in the next five years after shaving more risk off its books than any other large bank in the last few years, according to a new research report by veteran banking analyst Mike Mayo.
Citi, his top stock pick, should show the best improvement in return on equity and cost of capital of any of its large bank peers, Mayo wrote in his first note from Wells Fargo Securities, where he recently landed after leaving CLSA Americas earlier this year.
Banks are becoming companies that create value rather than destroy it for the first time in 20 years, Mayo wrote in his note. Their returns are rising and risk has been reduced, as has their cost of capital. Investors still remember the sting of the financial crisis, however, making bank stocks a "show me" story, he said.
Return on equity for the 10 largest banks should increase to 11 percent from 9 percent, Mayo wrote, as revenue growth of 25 percent outstrips expense growth of 15 percent. Mayo said he's not factoring lower taxes, lower regulatory costs, higher interest rates and an increase in capital markets activity into his model, so those numbers could go higher.
Banks' cost of capital — which means how much they pay in debt and equity to run their businesses — should fall to 9 percent from 10 percent because banks have reduced risk, Mayo wrote. "Safety is further enhanced by the strongest balance sheets in a generation, the highest level of equity-to-assets in 80 years, and enough cushion to absorb not one, but two financial crises."
The outspoken analyst is widely followed on Wall Street, but was one of several analysts cut by CLSA Americas in February when it closed its U.S. research operations. His tough questions during analyst calls have gotten him banned by banks in the past, but his criticism of the sector before and throughout the mortgage crisis has won him the praise of Jamie Dimon when it turned out to be correct.
He recently called the banking sector the "Lebron James" of the stock market. "They have incredible defense, the most resilient balance sheets in a generation, but now with this pro-growth agenda, they might also have a little bit of offense, too."
There are some risks to consider, Mayo wrote in his note Wednesday. Sloppy lending, higher costs, poor use of capital, increased risk-taking in trading, unforeseen moves in interest rates and unpredictable regulation are among them. In addition, while the last seven years have been the worst revenue generating years for the big banks since the 1930s, forecasts for improvement could fall short.
Citi shares are trading at $68.10, and his price target for 2022 is $140. He rates the stock an outperform.
Bank of America and JPMorgan Chase also get outperform ratings from Mayo. Bank of America shares trade at $24.61 and his three-year price target is $40. JPMorgan, which trades at $93.06, has a three-year price target of $130.
Mayo favors shares of Goldman Sachs, rated outperform, over Morgan Stanley, rated market perform. Goldman's fixed income trading operation has stumbled and is being repositioned but the rest of the bank is performing well, he says. "It is evolving from FICC (fixed income) to FACC — financing, asset manager client, cash securities, and corporate clients." Morgan Stanley has moved to emphasize wealth management and its business is more tied to the economy, he said.
Goldman shares trade at $229.60 and his one-year price target is $265; Morgan Stanley trades at $47.35 and his price target is $48.
-- With reporting by CNBC's Jason Gewirtz.