TFC - Truist Financial: My Oh My Another Strong Buy

2023-09-27 07:00:00 ET

Summary

• Truist Financial, formed through the merger of BB&T and SunTrust, has faced persistent pressure in the regional banking sector.
• The company is focused on simplifying its business, reducing expenses, and improving capitalization.
• Despite headwinds, Truist stock remains undervalued and offers a conservative price target of $40/share with an upside of over 23% per year.

T his article was coproduced with Wolf Report.

Prior to the merger between BB&T and SunTrust, I was a customer of BB&T.

When the two regional banks merged and formed Truist Financial ( TFC ) I decided to take by business elsewhere.

I've been watching Truist since the late 2019 merger, hoping to see whether or not the synergies would provide an opportunity for me to become a shareholder.

In this article, we will provide you with an update, as the price has become attractive at current levels.

The regional banking crisis and decline, as well as overall fear in the sector, have seen this company under persistent pressure for the better part of the entire year of 2023.

Both upside as well as risk, but upside trumps risk

Most analysts seem comfortable with a "hold" rating on Truist at this time - though there are a few like us who consider Truist's sell-off and risk to be overblown.

This is the stance we hold.

When it comes to the trends we saw here - potential HTM losses in bond portfolios which could put bank capitalization rates and CET-1 ratios in trouble - our stance was very early on that for some of these banks, what was being said and the way the share prices reacted was extremely exaggerated. (Source: Truist IR/2Q23 )

Truist is one of the top 10 commercial US banks with a very strong retail and commercial banking market share in seven of the 10 fastest-growing markets in the country. (Source: Truist IR/2Q23).

It has a solid mix of offerings, with capabilities across the board.

Truist is still in the phase of "simplification," and it's likely that this will be ongoing for some time.

Remember, the merger for Truist went through in 2019/2020, so it's been 2-3 years, which for a bank this size still requires more work. That's also the reason, in our view, why Truist's development hasn't been as positive as U.S. Bancorp ( USB ), another bank but one that at least isn't trading at the lows we're seeing in Truist.

Still, similar trends there, and the valuation has been down again as well since August.

Like all banks we cover, Truist seems to focus on simplification through things like digitization, consolidation of the workforce, reduced geographic exposure, and some restructuring of business.

A $750M savings program is underway. The reason that we're fairly positive about this is that we've seen similar savings programs and similar steps taken by European banks, such as Swedbank ( OTCPK:SWDBF ) and Nordea ( OTCPK:NRBAY ), and they've mostly turned out well.

We, therefore, see a good indication that TFC eventually is going to realize similar results here as well. (Source: Truist IR/2Q23 )

Expense growth is the real problem here - because as we see key rates increase, obviously the bank's net interest income, or NII, is going to be increasing.

What seems to worry most investors about TFC, the expense growth rate already is estimated to be significantly lower in 2024 than in 2023.

This bank's capital ratios and CET-1 are significantly below other banks where we usually invest.

For 4Q23, we have an estimated CET1 of 10%, potentially at 12% if the bank were to divest its TIH ownership. The banks we typically invest in are at 15%-19%.

But here, like with costs, capital ratios are expected to significantly improve over time. If you're willing to hold and invest in Truist until 2026, then you should see a remarkable payoff on this front.

So, Truist is on a business push to simplify the business, lower expenses, accelerate its franchising model, improve the capitalization, and align the executive comp.

All of these are positive things, and going through earnings and current trends, we have conviction that this is the direction the company is going. (Source: Truist IR/2Q23 )

The latest earnings we have for Truist are the 2Q23 earnings.

These were positive, but unfortunately below consensus - which is part of the reason why the company is actually down here.

Improved digital momentum is all well and good, but we saw expense growth of 4.7% YoY and lower net income.

Some trends were good - ROTCE of 19% still over $1.2B in net income - but no one likes seeing EPS go down.

The company's YoY EPS was down 16%, due to NPLs and higher expenses.

Compared to some European banks, TFC has significantly higher NPLs.

That's also why Truist, compared to say a position in Handelsbanken ( OTCPK:SVNLF ) is only at 20% of the size.

Handelsbanken has a comparable NPL of exactly 0.0%. (Source: Handelsbanken 2Q23). Excessive quality comes first, but Truist does have quality and significantly higher potential for better returns.

Loans are flat, and EOP loans are down slightly, with some deposit decline.

However, that doesn't really bug us. Why?

Because the net interest margin spreads when looking at deposits vs. liabilities are actually going in the direction we expect in this macro. Depositors always are looking for good investments, and the effects are actually less than one would expect because much of TFC's deposits are noninterest-bearing.

That being said, TFC is going to continue to suffer from the current environment , where higher yields are actually fairly easy to find.

Just look at what we're writing about daily. If someone wanted 5%-7% a few years back with safety, we would have been at a loss.

Today, it's almost easy.

However, you need to consider banks as long-term investments.

What's happening here not just with Truist but with any bank worth its salt is that the banks are now accumulating loans and investments, and they're doing so at significantly higher interest rates. (Source: Truist IR/2Q23 )

It's a question of the potential HTM losses, and the bank is now, continually, securing solid returns from what one could consider investment/maturity transformations.

When interest rates start holding or start declining, what we're going to see here is that Truist, like other banks, will be enjoying longer times of higher interest rates - and when you combine this with the advantages of the bank's geographical exposure, this leads me to look at this bank with a high conviction for the future.

Much as with other investments we cover, the current decline in share price is not reflective of a similar trend in EPS drop.

Not as bad as we're seeing.

The company is growing over time in revenues, its net income is growing, and its profitability metrics and returns are good when considered in the context of this macro.

Efficiency ratios for banks are under pressure, and with the expense guidance now in at the top part of the previously guided-for range, we expect management to be fully focused on reducing the expense side of this equation.

Management made comments exactly to this fact in the latest earnings call - and given how much we like banks, and seeing efficiency ratios of even above 50%, we will say that Truist has a lot of potential for improvement.

Truist went through one of the biggest mergers of the recent decade in US banking. It's only natural that such a development is fraught with ups and downs, especially going into an environment such as this.

As long as the core and fundamentals remain strong, and we see movement in the right direction, we really have no issue with this.

And it's our stance that we're actually still seeing this going the right way.

We've been part of merging organizations, and we know such processes are extremely time consuming and come with unforeseen roadblocks. It's therefore our stance that you shouldn't overreact to what's currently coming out of Truist - because it will improve. (Source: Truist IR/2Q23 )

So we are seeing a slight decline for this year.

This seems like a likely outcome, with somewhat higher revenue, but significantly higher expenses. However, the company also is very clear that 3Q23 will bring a decline in adjusted expenses and see improvements going into next year.

Truist has seen significant punishment, and much like with other banks, we believe it's gone far too deep here. Truist has significant upside, even with a double-digit EPS decline this year, flat next year, and no earnings growth until 2025-2026E when the bank gets its ducks in a row.

Let's look at the bank's valuation.

Truist Valuation - Plenty to like about A-rated banking at a 7%+ Yield

Whenever you're able to get something like an A-rated or high BBB-rated institution at a 7%-8% yield, you know you're potentially in for something good.

The last time Trust was this cheap was during the COVID-19 crash.

The bank is now trading at a normalized P/E of around 7.2x, compared to a typical of 14.2x - so we're essentially talking a 50% P/E discount.

Obviously, some discounting is justified based on where the bank currently is. And we can understand your frustration if you invested prior to the regional banking crash - because you're then down quite deep.

All you need to do to get a picture of what could happen here is one graph.

Our investment M.O. is one of simplicity.

We find undervalued businesses that come with qualitative fundamentals, dividends, a good business model, and other safeties.

We invest in them, and we keep our investment, unless something fundamental changes, for as long as the business is not excessively overvalued.

If it becomes overvalued to where we consider it fairly valued, we trim/sell, and repeat the process with another company.

And it's because of companies such as this one.

What's the likely RoR for Truist?

Here's how we see it.

Truist is a bank that should, over the long term, even with the risks mentioned, trade at least at a level of 10x P/E.

Forecasting this bank at a 10x P/E forward ratio means that we, even with declines and an EPS growth rate until 2025E of only 2% per year inclusive of the reversal, are seeing an upside of 23.4% per year.

That's what we consider the conservative thesis for this bank.

If we're speculating on the upside, and a reversal to 12-14x P/E if this bank gets its "ducks in a row," then that upside easily turns to 35% annually at a 12.5x P/E, or over 40% annually until 2025E, on the basis of a 14.5x P/E.

None of these estimates are outlandish or unrealistic if we see a turnaround here.

Because actually losing money over the long term seems like such an unrealistic prospect here, that's what I base my thesis upon.

Now even if you forecast Truist at 6.8x P/E, are you losing money inclusive of dividends here?

So you can argue back and forth as to what you can expect from Truist here, but in order to expect an eventual loss of capital here, you would have to either expect a complete deterioration of Truist's business model (and then you shouldn't invest in the first place), or your timeframe should be very short (and again, then you shouldn't invest in this market at all, as I see it).

In any other situation, we see the inevitable outcome for a Truist investment as one of a positive nature.

Other analysts?

We're talking 24 S&P global analysts following Truist.

Out of those 24, 10 are at "BUY" or equivalent - most are currently at "Hold" But those analysts go from a low range price target of $29 to one of $50/share, with an average of $37/share.

We go to $40/share for this company.

This marks a current upside of over 25%, and that is why we're at a "Strong Buy" for Truist Financial.

This is a great opportunity, together with Lincoln National ( LNC ), in the finance sector, and one we consider one of the strongest and safest on the NA market at this time.

If you have any questions, let me know - otherwise here is my thesis for Truist.

Thesis

• Truist Financial is a class-leading regional bank with above-average fundamentals and a great yield. While the bank is still digesting what we would consider one of the more relevant M&As of the past decade in US banking, we hold a strong conviction that the bank eventually will come out on top.
• Truist Financial remains undervalued despite some headwinds in 2Q23 due to unfavorable expenses and NPL development. None of those things are out of character but were perhaps slightly worse than expected. The pathway to recovery has simply grown slightly longer, and the market is reacting to it.
• We consider Truist a "Buy" with a conservative PT of $40/share. This represents a 2025E 9.9x P/E and comes with an upside of over 23% per year from the current valuation. I'm long the bank at an average cost basis of below $30/share.

Closing Thoughts

Just as I was going to publish this article, I opened up Barron's to read an article by Jacob Sonenshine titled "A Troubled Bank Merger Is Finally Fixing Itself."

"The payout totals just under $2.8 billion a year, which is easily covered by next year's net income of $4.8 billon. Even an earnings disappointment should still leave plenty of cash to return to shareholders."

I like Barron's and I'm happy to see a positive spin on this 7.4% bank. I concur with the Barron's writer:

"Given Truist's earnings potential, you're getting a good dividend while we wait."

Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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