We are downgrading our recommendation on Itau Unibanco S.A. – ADS (ITUB) to Underperform from Neutral based on the deterioration in its credit quality. The company's first quarter 2012 adjusted earnings were down 5.4% sequentially and 2.6% year over year, reflecting increase in provision expenses from rising default levels.
Though the company's solid business model, diversified product mix, growing service fees, cost controls and expanded credit portfolio are encouraging, we believe that besides asset quality concerns, increasing competition and the stressed conditions in the Brazilian economy pose risks for the company.
Our six-month target price of $13.00 per ADS equates to about 6.9x our earnings estimate for full year 2012. This price target implies an expected negative return of 6.2% over that period, which is consistent with our long-term Underperform recommendation on the ADSs.
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