2023-07-12 11:53:03 ET
Summary
- Bank of New York Mellon is set to publish its Q2 results on July 18.
- We touch upon some of the notable earnings-related sub-plots.
- We conclude with some thoughts on why BK appeals to us at this juncture.
Introduction
This year, the stock of the world’s largest custodian bank (with assets under custody of $46.6 trillion)- Bank of New York Mellon ( BK ), hasn’t set the world on fire , with YTD returns of low single digits. That unremarkable return profile has the potential to change over the next few weeks, with an important catalyst on the horizon; next week, on the morning of July 18 , BK will publish its Q2 results, followed by an earnings call four hours later at 10:30 AM est. Here are some important things to note, if you’re a prospective or existing stakeholder in BK.
Earnings-related Considerations
Long-standing owners of BK's stock are unlikely to be on tenterhooks as this bank has almost always surpassed expectations during earnings season. For context, over the last 12 quarters, dating back to Q2-20, BK managed to beat street estimates 11 of those times, falling short only in Q2-2022. Crucially the Q2-22 miss was only due to one-off items, and adjusting for that development, one would have witnessed an earnings beat of 4%. All in all, you’re basically looking at a stock that manages to beat bottom-line estimates by 6% on average.
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In Q2-23, YCharts consensus is currently estimating an EPS of $1.213; whilst this would represent sequential progress from what was seen in Q1-23 ($1.12), on a YoY basis, it would represent a marked slowdown in the pace of earnings growth. In Q1, BK had delivered adjusted earnings growth of 20% (30% on an unadjusted basis), but the current consensus figure for Q2-23 would translate to earnings growth of only ~5% (on an adjusted basis). As noted earlier, the year-ago EPS of $1.03 was adversely impacted by one-off litigation issues to the tune of $0.12 , and adjusting for that you’d be looking at an EPS of $1.15.
The run-rate on the topline as well is poised to slow in Q2; in Q1 BK delivered solid 9% topline growth (11% on an unadjusted basis), but based on the current estimate of $4.36bn , investors should brace themselves for a slowdown in the growth to mid-single-digit levels.
Net interest revenue ((NIR)) growth in Q1 came in at a whopping 62%, but we think this may slow in Q2, particularly considering the steep base effect of last year (In Q2-22 it had grown at 28% vs just 7% in Q1-22). Just for some added perspective, do note that BK management had only budgeted for 20% NIR growth for FY23 at the start of this year.
A lot of observers will be curious to see if BNY Mellon has been able to demonstrate fee growth progress in Q2, particularly given the unappealing trend in recent quarters. In Q4, fee growth was flat, but management had stated then that underlying fee growth would return in 2023; That did not come to fruition in Q1 either.
We suspect in Q2, one would finally witness some positive growth on the fee side. Firstly, some postponed client volumes in asset services are likely to come back, management also touched upon an improving margin cadence on new deals. Then you have issuer services fees which typically tend to pick up in the second quarter on account of the dividend season. Pershing fees and openings could also receive an uplift from the recent integration of Snowflake Data Cloud for Pershing X’s clients.
The market will also be keen to see if BK has been able to keep its costs in check for yet another quarter, following 8% expense growth seen in FY22 (BK management’s goal is to keep this growing at only 4% YoY on a constant currency basis). In fairness, the expense management in Q1 was very well done, coming in only at 3% YoY despite Q1 receiving a bump from one-off incentive comps associated with retirement-eligible employees. Much of this was on account of efficiency savings, and stricter execution in functions such as legal, purchasing, business development, etc.
Over recent quarters, BK management has done well to enhance the liquidity profile of the bank, with the liquidity coverage ratio ((LCR)) at elevated levels of 118% for two straight quarters now (the regulatory minimum is 100%). With the fears of the regional banking crisis abating in recent months, we wonder if we will see a similar ratio for the third straight quarter.
Earnings reports
Closing Thoughts - Why BK's Stock Is A Buy
On paper, BNY Mellon may not necessarily be of the most exciting businesses around, but it is still poised to deliver a higher cadence of earnings growth every year, for the foreseeable future. According to YCharts consensus estimates, BK will likely deliver only 4% earnings growth this year; however, in FY24 this is poised to increase by a higher margin of 7.4%, and the following year, by an even greater margin of 9.3%.
YCharts
Normally when faced with such an encouraging earnings growth runaway, you’d think the stock would be priced at a premium. That isn’t the case. BK currently trades at less than 1x book value (which is the historical average), and more crucially on a forward P/E basis, you can pick it up at a ~9% discount over its long-term average of 9.4x!
YCharts
What’s also underappreciated is the quality of shareholder returns that BK offers (their goal is to distribute over 100% of earnings to shareholders by way of dividends and buybacks). For two successive years, BK had been doling out healthy dividend growth within the 9% threshold. Given the high base of dividend growth in recent years, one could’ve excused BK for slowing down the pace of growth this year.
However, the outcome of the recent stress test results has bolstered their confidence even further. Whilst quite a few banks will witness a spike in their Stress Capital Buffers ((SCB)) from October 2023, the Fed has not asked BK to raise their buffer from the regulatory minimum of 2.5%. In effect, BK intends to be very generous, with its Q3 dividend distributions which are poised to spike by 14%!
For context, do consider that the subsequent dividend hikes announced by banks who were part of this stress test were only half the pace of BK's forward dividend growth. Besides, only one bank- Wells Fargo ( WFC ), announced a superior hike than BK.
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Interestingly enough, even before the recent hike, BK’s dividend yield was already quite compelling relative to what you normally get (you can currently pocket a yield of 3.31%, 40bps higher than the 4-year average). If you incorporate the likely hike that will come through in Q3, you could be looking at a much superior differential of over 80bps at 3.76%).
BK's generosity isn't linked to dividends alone; currently, the bank is in the midst of carrying out a mammoth $5bn share buyback program announced in January (this equates to over 14% of the total market cap). In Q1, the company spent $1.3bn in buying back the stock, and whilst management did suggest that they would reduce the pace in Q2 (mainly on account of the debt ceiling concerns), we believe this will pick up once again, given the encouraging stress test results, and where the stock is currently perched.
Speaking of BK’s stock, note the long-term price imprints over the last 15 years have tended to move within a certain channel. Currently, that range has narrowed to the $40-$60 levels. If one were to consider a long position using the two boundaries as pivot points, it’s fair to say that the risk-reward for a long position looks very promising (R:R of 3x).
Finally, it's also worth considering that BK could work as a fine rotation option within the US financial services terrain. Currently, its relative strength ratio versus the iShares US Financial Services ETF is a good 20% off the mid-point of its decade-long range and may see some mean-reversion in the periods ahead.
For further details see:
Is BNY Mellon A Good Buy Ahead Of Its Q1 Results?