Play Brazilian Economy with Itau

We are maintaining our Hold on Banco Itau Holding Financeira S.A. (or Itau) (ITU). Itau paid a 25% stock dividend on June 10, for which all data in this report have been adjusted. Itau will report second quarter results on August 5.

Positives for Banco Itau include the company’s robust results, improved diversification of its product mix, growing service fees, solid insurance business results, cost controls, an expanded credit portfolio, and an increased demand for credit within the growing Brazilian economy. We believe the combination of moderate economic growth, increasing credit demand, and moderately high interest rates are positives for the Brazilian retail banking industry in the short term.

Despite the many positives of the Itau story, we have concerns regarding asset quality deterioration, increasing competition, the volatility of the Brazilian economy, and the impact of high interest rates. As to asset quality, given Itau's rapid loan growth and expansion into lower-income markets, we expect asset quality metrics to deteriorate from current strong levels.

At its current price, Banco Itau trades at 12.6X the 2008 consensus estimate and 11.2X the 2009 consensus estimates, well above the industry medians, also based on consensus estimates. While Itau’s consensus estimated growth rate at 14% is above the peer median, Itau’s dividend yield at 2.7% is below par.

Given these facts, we think Banco Itau is fully valued and see limited upside. Our $21 price target represents roughly an 11 ½X P/E multiple of our 2009 EPADS estimate of $1.84, providing a PEG (P/E divided by estimated future growth rate) of about 0.8X, roughly in line with the industry median.

Read the full analyst report on ITU