On Friday, we noted that, after a lengthy and painful stretch in the penalty box, financial stocks had finally come into their own. They performed strongly in 2012, and we believe they will continue to do so through 2013. This success reflects the belated but inevitable reconciliation of the growing business strength of these institutions with stock prices that have only recently begun to reflect that business improvement.
In this column we briefly highlight six additional financial names (Last Friday we focused on JP Morgan, American Express and Wells Fargo.) that we think should be of interest in 2013 or give a good read into the banking group's earnings this quarter.
Goldman Sachs (GS) reported much better-than-expected earnings of $5.60 vs. a $3.90 consensus. Strong trading and investment banking results drove the upside with revenues exceeding more than $1 billion above the estimates. However, tight expense controls, including a 39% compensation ratio, also added to the numbers. Management continues to outperform its major Wall Street peers. GS is attractively valued at 10.8 times 2013's earnings.
U.S. Bancorp (USB) reported an in-line quarter at $0.72 or $0.75, adjusted. A weak net interest income (NIM) continued to drag on revenue growth. Management continued to re-affirm the long-term market share gains and growth rate. USB will likely continue to lag a bit until interest rates begin to rise, but the stock is nonetheless attractively valued, as it is trading at 10.7x 2013's earnings.
Bank of New York-Mellon (BK) also reported an in-line quarter of $0.53, due to a major drag from its net interest income ratio (NIM). Foreign exchange trading and securities lending also weighed on results. While the headline number met expectations, it was among the lower quality reports to date as it included a lower than expected tax rate, as well as some one-time gains and reserve releases. Nevertheless, BK should be a big beneficiary of rising interest rates. While BK has consistently had modestly disappointing quarters over the last few years, where it had low-quality earnings that allowed it to meet EPS expectations and be light on revenues, we think the company is closer to getting its act together. The stock is attractively valued, trading at 11.7x 2013's earnings.
BB&T (BBT) reported better-than-expected earnings of $0.72 vs. $0.70 consensus. The upside was driven by higher fee income from mortgage banking and insurance services. The company continues to expand its balance sheet from 2% to 4% loan growth, offset by a contracting net interest margin. Management reaffirmed double-digit earnings growth through market share gains even in-light of the still sluggish economy and interest rate pressures. BBT is well valued at 10.6x 2013's earnings. As the company has very strong capital ratios, we are also expecting management will implement a nice increase to the dividend later this year.
State Street (STT) reported better-than-expected earnings of $1.11 vs. $1.00 consensus. Revenues were above expectations led by rising assets under custody growth. Long-term expense reductions and share buybacks helped the bottom line during the quarter. Management further surprised investors with another $100 million-plus of expense reduction initiatives. The company affirmed double-digit earnings growth targets going forward. The stock is also attractively valued, as it is trading at 12.2x 2013 earnings.
Morgan Stanley (MS) reported better-than-expected earnings of $0.45 vs. $0.26 consensus. Revenues were $400 million higher, led by the institutional securities unit. The real surprise in the quarter was a 17% pre-tax margin generated by its wealth management division. Aggressive headcount reductions and re-engineering initiatives are beginning to boost company margins and profitability levels.
Management discussed in detail how MS will again attain a return-on-equity (ROE) level in the teens in the coming year(s). These recovering profitability levels do not take into account a rebound in market activity, which would drive further upside in the earnings and share price. MS is compellingly valued at 85% of tangible book value of $26.81 and is trading at less than 10x normal earnings.
Overall, financial companies continued to see improving fundamentals this quarter. Some are doing better than others, but there is a marked overall improvement for the group. Earnings will only get better as economic activity returns to normal and interest rates begin to rise.
Even after a strong 2012, the sector is still playing catch-up with the rest of the market; the full recovery for financials is still in its early innings. We expect 2013 to be an attractive follow-on year to 2012, not only for the well-deserved resurgence that financials should still enjoy, but also because their business success this year should warrant attractive 2013 market performance.
Of the financials discussed above, our favorites are BBT, STT and MS. We also like GS and BK.