2023-12-11 10:53:46 ET
Summary
- Bank of New York Mellon is downgraded to a Buy rating from a prior Strong Buy in August, in line with current consensus from Wall Street.
- Positive points are +3% dividend yield, dividend income growth, equity and earnings improvement, growth in AUM/AUC and inflows.
- Headwinds are a share price now 11% above its moving average.
- Expected continued improvement in the S&P 500 and market values should be an upside to this bank and its fee-driven assets.
Stock Snapshot
As we are in the final stages of this quite turbulent fiscal year in the financial sector, for today's research note I'll be revisiting a global bank stock I covered back in August.
Some quick facts about Bank of New York Mellon ( BK ) are that it calls itself the bank of banks , does business in 35 countries, has $1.8T assets under management and +$45T assets under custody or administration. It also has a well-established wealth management shop as well.
Since my last rating in August when I gave it a strong buy rating, the share price has gone up +7.6%. This is after it had already risen +14% since my first rating in May which gave it a buy . So, it appears my bullish outlook proved right both times.
BNY - Price Since Last Rating (Seeking Alpha)
In today's note, however, we will be applying my updated rating methodology as well as considering the most recent quarterly results.
Scoring Matrix
This article uses a 9-point scoring matrix that holistically considers multiple angles of the stock, with an emphasis on cashflow potential for investors and fundamental trends from the key accounting statements publicly available such as the balance sheet and income statements, as well as a future-looking outlook on this stock.
Today's Rating
Based on the score total in the score matrix above, this stock is getting a rating of buy .
This is a slight downgrade from my prior strong buy rating.
Compared to the consensus rating on Seeking Alpha today, my rating agrees with the sentiment from Wall Street and the SA quant system:
BNY - Rating Consensus (Seeking Alpha)
Dividend Income Growth
This section uses dividend growth data to explore the 10-year dividend income growth for a hypothetical investor owning 100 shares, to determine whether this stock is a great dividend income opportunity.
The chart above tells the story of a steady dividend growth between 2013 and 2022.
If my portfolio had bought a hypothetical 100 shares in 2013, when the annual dividend was $0.58/share, I would have seen $58/year in dividend income. Compare that to 2022 when the annual dividend went up to $1.42/share, and the dividend income grows to $142 a year. That is a +144% growth over this 10-year period.
If this trend continues, and if we extrapolate to 2032 with the same 10-year growth rate, our dividend income would grow to $346/year.
Also one should consider from the most recent earnings release that the company had the capacity to pay out $333MM to common shareholders and its capital strength is evidenced by a CET1 ratio of 11.4% and liquidity coverage ratio ((LCR)) of 121%.
So, in this category, I will call it a strong buy, on the basis of proven dividend growth of +100% over 10 years, and existing capital strength going forward, as well as a history of stable quarterly payouts.
Dividend Yield vs Peers
This section uses dividend yield data to compare the trailing dividend yield vs 3 similar peers in the same sector, to determine if this stock presents the most competitive dividend yield on capital invested.
In the above chart, I am comparing the trailing dividend yield of three stocks I picked as they are all large banking stocks based in the US and trading on the NYSE. My focus stock, BNY Mellon, came in the middle of this peer group with a trailing yield of 3.22% (forward yield 3.42%) vs State Street ( STT ) which has a slightly higher yield, and JPMorgan Chase ( JPM ) trailing behind with a yield of 2.55%.
For this reason, I will give it a hold in this category as its yield is past +3% but slightly less competitive than its peer State Street who also is a major custodian and asset manager.
Revenue Growth
This section explores this company's revenue growth trends over the last year, using data from the income statement.
What the data tells us is that in the quarter ending September the firm achieved $4.37B in top-line revenue, vs $4.3B in Sept 2022, or a roughly 2% YoY growth, practically flat. There has been a general improvement trend, however, since the quarter ending December 2022.
Since this firm makes quite a lot from interest income, let's take a quick look at the table below:
Given the current high rate environment, we can see that total interest income jumped +178% on a YoY basis, but interest expense also jumped an incredible +283%, leaving net interest income ((NII)) to rise only about 10% on a YoY basis.
This is more evidence that high rates are a double-edged sword for a bank, so what I think works in their favor is diversification with non-interest revenue sources as well.
However, in the most recent quarter's results the bank reported "fee revenue flat YoY", and drilling down further the investment/wealth management division saw "total revenue down 4% YoY" while the securities services division only went up "1% YoY.".
One key metric in this business is whether net inflows of new money are coming into the firm each year, since they make money from managing others' money. In this regard, the subsegment of wealth management I think should be kept an eye on since "wealth Management client assets of $292bn were up 14% YoY, primarily reflecting higher market values and cumulative net inflows."
In this category, I will call this stock a buy on the basis of positive YoY revenue growth, as well as significant growth potential of the wealth management arm. More importantly, with CME Fedwatch predicting the Fed will keep their policy rates the same this month, I expect it will continue to drive the strong interest income despite also driving higher interest expense as well.
Earnings Growth
This section explores this company's earnings (net income) growth trends over the last year, using data from the income statement.
What we can learn from this data is that in the quarter ending September the firm achieved net income (earnings) of $1.03B vs $388MM in Sept 2022, a +171% YoY growth. Further, it should be noted that since Sept 2022 the earnings have been on a positive growth trend, increasing for most of the quarters since.
Two items the company mentioned as contributing to lower expenses were "noninterest expense decreased QoQ, primarily driven by lower litigation reserves," as well as "provision for credit losses was a benefit of $13mm, primarily reflecting a reduction in reserves related to financial institutions."
Further, "noninterest expense down 16% YoY, primarily related to the 3Q22 goodwill impairment associated with the Investment Management reporting unit."
Also to note is that total non-interest expenses were lower in all three quarters after Dec 2022, as per the income statement.
Going forward, I expect the positive net earnings trend to be sustainable as I anticipate revenue strength to continue as already mentioned and this will offset costs which have lately shown declining trends. But any inflation-driven costs of doing business should also stabilize as the Fed avoids any further rate hikes, and the recent University of Michigan survey showed inflation expectations plunging, according to a CNBC story this week.
For this reason, I will call it a buy in this category rather than a strong buy because I want to see a few more quarters of positive earnings growth materializing first so as to show a longer-term trend of continued earnings growth.
Equity Positive Growth
This section explores this company's equity (book value) growth trends over the last year, using data from the balance sheet .
The good news from this data is that total equity jumped to $41.13B in the quarter ending September vs $39.89B in Sept 2022, a +3% YoY growth. Further, the trend since Sept 2022 has been on a positive uptick.
A driver of this is the significant drop in total liabilities, which dropped to $364.17B in September vs $388B in Sept 2022, a +6% YoY decline, while total assets declined only about +5% on a YoY basis.
I will call it a buy in this category on the basis of positive but very low improvement in equity.
Share Price vs Moving Average
This section explores the current share price compared to the 200-day simple moving average ((SMA)), to decide if it currently presents a buy, hold, or sell opportunity.
What we can see from this chart, showing Friday's close price of $49.06, is that it is now nearly +11% above the 200-day simple moving average (orange line) that I am following.
Considering that we already had two really nice dip-buying opportunities this spring and autumn, as the chart shows, and the price is approaching its February highs again, in my opinion, it does not appear to be a great buy opportunity at this price now, when looking at the larger picture, unless it was just to snag the +3% dividend yield I mentioned earlier.
In that case, I would rather buy State Street shares right now who have an even higher dividend yield and are trading only +3% above their moving average:
STT - Share Price (Seeking Alpha YCharts)
In this case, I will call BNY a hold , as I think it is too valuable to sell off, being a profitable company and one of the world's systemically critical banks .
Valuation: Price-to-Earnings
This section uses valuation data to explore the forward P/E ratio and whether it presents an undervalued opportunity.
The data story this tells us is that the forward P/E ratio of 10.77 is +4% above the sector average, so not a lot.
But the question is whether a nearly 11x multiple is justified?
What I think is driving this premium, when tying back to the financials and share price I discussed already, is the spike in the share price far above the moving average and quite far above its autumn lows. It is also around 23% above its spring lows ($40/share vs $49/share today).
However, at the same time, earnings are also on a positive trend. Besides the +171% YoY earnings growth, we can also see a +91% improvement vs Dec 2022 and a +19% growth vs June 2022.
So, I will call this stock a buy in this category as I believe the price-to-earnings multiple is justified due to the significant earnings growth. I would not consider it a strong buy, however, at an 11x multiple but perhaps if that share price came down a bit it could bring that multiple down to below its sector average.
Valuation: Price-to-Book Value
This section uses valuation data to explore the forward P/B ratio and whether it presents an undervalued opportunity.
This data point tells us the forward P/B ratio of 1.04 is around 8% below the sector average.
The driver of this, I think is the fact that this is an equity-heavy company at +$39B total equity which has gone up and keeps going up it seems, despite the share price also going up.
In my opinion, it's a no-brainer to call it a buy at a multiple of just over 1x, although not quite a strong buy as I would like it to drop just below a 1x multiple eventually if that share price cools off. That remains to be seen, considering that this firm managed to beat all 4 earnings estimates in the last year, and if it beats again for Q4 it could keep that share price in bullish territory. So, I think they will need to grow equity at a lot more than just 3% YoY to make up for that price spike.
Risk Analysis
This section identifies a key risk to consider about this company and what its probability and impact could be to the business.
Because a lot of this firm's business model depends on earning fees on the value of assets managed, the risk I see is either a mass exodus of client funds through outflows (which has not happened as of now) or a significant decline in the market value of the assets being managed, whether they be bonds or equities or both.
This could be a downside risk as it could impact fee revenue in the next few quarters, but could also be an upside risk as it could provide tailwind to fees if we see the market going into major bull territory soon.
So far, according to the recent earnings comments , "AUC/A increased 8%, primarily reflecting higher market values", and "AUM increased 3%, primarily reflecting the favorable impact of a weaker U.S. dollar and higher market values."
Also, if you look at market momentum data, the S&P 500 index (a key market index the financial media tracks) has seen a 1-year price return of +16%:
As far as looking forward to 2024, my confidence in further market improvement is supported by a Nov. 20th report from Goldman Sachs ' analysts:
US stocks are forecast by Goldman Sachs Research to have a modest return next year, as above-consensus economic growth is partly offset by high equity valuations.
The S&P 500 index is expected to rise to 4700 by the end of 2024, representing a price gain of about 5% and a total return of around 6% including dividends. Our economists' forecast for US GDP growth of 2.1% in 2024 is already reflected in stock prices.
So, the evidence supports a buy case for this stock on the basis that the risk of declining market values and client outflows is low.
Quick Summary
To summarize, I am still bullish on this stock and it continues to be in my portfolio watchlist since last year, as its holistic picture outweighs the higher share price now, although I am not as bullish on this price as in August obviously.
The positive tailwind comes from positive revenue and earnings growth, proven dividend growth for dividend income investors, a justified valuation, and positive equity growth.
Some headwinds come from the share price trading 11% above the moving average now, and a better dividend yield I can get from its peer State Street.
However, this is one of those legacy global custodian banks that is systemically critical with a +3% dividend yield to potentially add to an existing portfolio of diversified bank stocks that may include some regionals and global ones with a yield of +3% - 5%.
For further details see:
Bank of New York Mellon: Still A Buy At +3% Yield And Earnings Growth (Ratings Downgrade)