Buckingham's Bets: Value Expert's Bank Stock Bargains

As chief investment officer of AFAM Capital, John Buckingham is a leading value oriented money manager. The 30-year market veteran is also the editor of the top-ranked The Prudent Speculator newsletter and a contributor to MoneyShow.com. With earnings season underway, he offers a review of six bargains among financial stocks. First-quarter earnings reporting season began in earnest, and the news thus far has been very good, at least as far as the actual bottom-line figures versus analyst expectations. The Atlanta Federal Reserve Bank's widely watched GDPNow suggests Q1 U.S. GDP will expand by 2.8%, much better than the pessimistic forecasts issued earlier in the year. Even better, comments from a couple of Federal Reserve officials last week indicated the stronger economy is not likely to lead to a near-term shift back toward a tightening of monetary policy. Of course, even with a rate hike or two from the current 2.25% to 2.5% Fed Funds rate, Jerome Powell & Co. remain quite friendly, with the very low interest rate backdrop bolstering the case for equities. Obviously, we have no crystal ball when it comes to market timing, nor does anyone else for that matter, but we continue to believe that far more money has been lost in trying to avoid downturns, corrections and bear markets than has been lost in those events themselves, so we see no reason to alter our long-term investment plan. Indeed, we simply continue to buy and patiently harvest a broadly diversified portfolio of what we believe to be undervalued stocks, generally of dividend-paying companies, to be held for their long-term appreciation potential. Shares of Synchrony Financial rose after the financial services firm reported Q1 financial results, and are now up more than 42% in 2019, following a very rocky 2018. Synchrony said net interest income increased 10% from the first quarter of 2018 to $4.2 billion. Excluding the Walmart Inc. loan portfolio, which Synchrony is in the process of selling off (after losing the relationship), loan receivables increased 17% on a year-over-year basis to $79.7 billion. The company reported adjusted EPS for Q1 of $1, which was solidly above the consensus estimate of 89 cents. The PayPal Holdings, Inc. relationship is definitely paying dividends and helping to offset the eventual loss of the WalMart account. The Walmart loan portfolio is slated to be sold in Q3 or Q4, and while this will impact near-term performance, we would expect the portfolio will not be hard to sell and some of the proceeds will be used to further reduce share count while others will be utilized to strengthen the firm's financial position and long-term business prospects. Synchrony management is still targeting loan growth of 5% to 7% for 2019, which seems reasonable to us. The shares trade at just 7.4 times next 12-months adjusted EPS consensus estimates and yield 2.5%. Our target price has been lifted to $51. Shares of regional bank KeyCorp had an up and down week, ending off less than 1%. The bank reported Q1 earnings of $0.40 per share, versus the consensus analyst estimate of $0.41. Revenue for the period of $1.52 billion also came in almost 5% below expectations. Net interest income for the quarter was largely in line with expectations, but fee income missed investor expectations. KeyCorp maintained its guidance for full-year 2019 of $4 billion to $4.1 billion in net interest income and $2.5 billion to 2.6 billion in fees. The big disappointment in Q1 was in investment banking. Management did explain on the conference call that it was more of a timing issue with the government shutdown and delays in deal closings. The investment banking pipeline seems strong and should drive much stronger momentum for the rest of the year. We continue to like KeyCorp and think that the recent acquisition of Laurel Road bank's digital lending business is interesting. We also believe that the bank's efficiency can continue to improve as it benefits from the full integration of its recent acquisitions. Shares currently trade at less than 9 times NTM adjusted earnings expectations and carry a 4.1% dividend yield. Our target price now stands at $27. Diversified financial firm Bank of America Corp. reported earnings per share of 71 cents, versus the 66 cents estimate, for Q1 2019. While revenue of $23.2 billion outpaced analyst expectations, like many in the space, Bank of America's top-line growth was muted, but underlying cost controls and non-interest income streams helped drive favorable bottom-line results. Overall, expenses were down 4%, and with the average diluted share count down 7%, earnings per share increased 13%. The efficiency ratio came in at 57.5% and return on average assets came in at 1.26%, while return on tangible common equity came in at 16%, with all three representing improvements over last year. We continue to be fans of Bank of America and see it as one of our core financial holdings, though the dividend yield is presently only 2.0%. We see numerous long-term opportunities upon which the bank can capitalize, from its large deposit base and consumer lending franchise to its thundering herd of Merrill Lynch financial advisors and wealth managers. Credit quality remains solid and the stock is trading for just 10.2 times next 12-months estimated EPS. We've bumped up our target price for Bank of America to $41. Diversified bank Citigroup Inc. reported adjusted EPS of $1.87 per share in Q1 (vs. $1.80 est.), with the shares continuing their strong rebound in 2019 (up more than 33%). Generally, in-line revenue for the period was a bit lighter than Q1 2018, but favorable expense control and a lower overall tax rate helped net income growth. Return on tangible common equity reached 11.9%, helping to make management's goal for a full-year number of 12%+ seem achievable. Even with improving operational execution, a domestic rising rate environment (over the last couple of years), and faster growth markets around the globe (vs. its U.S. business), we believe that Citi shares trade far from their fair value. C is priced at just 8.8 times NTM adjusted EPS expectations and 90% of book value. We continue to see a more focused and recapitalized Citigroup as prepared to reward investors over the long-term. We like that the bank has good leverage towards the strong U.S. economy, while also having the potential to show out-sized benefits versus its peers from growth in Asia, Latin America and other emerging economies. Even though Citi faces plenty of operational headwinds in different segments of its business, we think the bank is on its way to achieving its low-50s efficiency-ratio target by 2020. Additionally, the current dividend yield now stands at 2.6%, and the bank continues to consistently buy back its stock. We've hiked our target price for Citi to $106. Bank of NY Mellon Corp. saw its shares fall after reporting Q1 results; the disappointing quarter saw the global financial services company post adjusted earnings of 94 cents per share, versus Street expectations of 96 cents, with revenue of $3.9 billion also coming up short of forecasts. Q1 results highlighted the difficult environment that BK continues to face. Revenue was down 7%, driven by declining fee revenue and net interest income compression. While expense control improved, with expenses down 1%, it couldn't overcome operational headwinds, as EPS declined 15%, due in large part to the flattening of the yield curve. While we were disappointed with Q1 and the recent operational performance, we maintain our patience and remain constructive on the fact that management has been adding initiatives to right the ship as BK has struggled with costs, the cyclicality of some revenue streams, and the overall low interest rate environment. While any benefits from rising interest rates may not be on the near-term horizon, we think the bank should be able to add clients as smaller asset managers increasingly outsource administrative and other functions amid a complex regulatory environment. While there is a lot of work yet to do to get Bank of NY Mellon turned around, we like that the company is well capitalized and that it has a management team committed to cost containment and driving growth. BK trades at 11.6 times NTM adjusted earnings expectations and yields 2.3%. We've cut our target price for BK to $62. Investment banking and brokerage firm Goldman Sachs Group, Inc. - $205.91, posted adjusted earnings per share of $5.71, versus the consensus analyst estimate of $4.97, in Q1 2019. The bottom-line beat was led by better expense management and a lower tax rate. Unfortunately, investors were seemingly more concerned about a modest top-line miss as revenue of $8.8 billion came in short of forecasts of $8.97 billion, and some 13% below the year-ago period. Management indicated that lower net revenue in institutional client services and investing and lending was primarily to blame. We continue to be long-term fans of GS and are constructive on the name given the prospects for stronger, long-term revenue growth, operating leverage, potential de-regulatory policies, and a possible higher earnings multiple than the current forward P/E of 8.4. We like the strategic changes that Goldman is undertaking, but we won't be surprised if it takes a few years for its efforts to begin to be truly rewarded by investors. Management is aiming to expand revenue in newer, less capital-intensive business lines, while optimizing expenses and capital in its traditional business lines. We believe the company's digital banking platform and expanding emphasis on wealth and asset management should increase long-term returns and drive some underlying stability. Our target price is now $287.

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