Bank Of America's Real Source Of Earnings Growth In 2014

Oct.16.13 | About: Bank of (BAC)

We'll get third quarter earnings from Bank of America (NYSE:BAC) this week and while an entertaining and informative conference call is virtually assured, given BAC's legal issues, I'll be looking for guidance on another number I consider to be of most interest to shareholders. CEO Brian Moynihan has been hard at work reducing non-interest expenditures virtually from the minute he took over as CEO; an effort known as 'Project New BAC'. In a nutshell, the plan is to reduce operating expenditures the bank feels are redundant or unnecessary so as to save billions of dollars annually. These smaller expenditures then result in tremendous operating leverage even if the bank can't figure out how to raise additional revenue. That scenario, by the way, is exactly what analysts are pricing into the stock right now.

I have been a huge proponent of Project New BAC and I am also a huge proponent of Moynihan. I think the company is doing a great job of handling its various lines of business as a result of the company-wide initiative and it is paying dividends in the company's earnings. BAC has thus far proceeded exactly on schedule with its plans to reduce operating expenditures by $8 billion per year.

If we examine the company's non-interest expenses for the past five quarters, a decent proxy for the lifespan of Project New BAC, we can see that the most recent quarter was the lowest amount of operating expenditures by far (from the most recent 10-Q).

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Despite a hiccup in the first quarter of this year, BAC's operating expenditures for the second quarter were over a billion dollars less than the comparable period last year. While this doesn't equate to the two billion dollars in savings per quarter BAC needs to complete Project New BAC's initiatives, it is half of that number and more proof that BAC is on its way to becoming a leaner, meaner, more profitable money center bank.

BAC has its operating expenditures completely under control after they ran rampant for years leading up the financial crisis, and I'm very excited about the progress Moynihan has made in reducing non-essential operating expenditures. With mortgage originations dwindling around the country due to the mini-spike in interest rates this past summer, those banks that have been right-sizing will be best able to weather the storm. Since BAC is involved in businesses that make it slightly less reliant on mortgage originations than other money center banks like Wells Fargo (NYSE:WFC), I think the combination of its expenditure cuts and business mix will enable it to keep churning towards record profits.

The one caution I would add is that if we see non-interest expenditures move up again, further due diligence will be required to understand why. BAC cannot afford to give up the progress it has made towards New BAC and I don't think it will. However, if we see the bank step bank from the gains it has made I believe the market will react very negatively to that and send the stock lower. With the stock trading for only 10.5 times next year's earnings, the margin of safety is small given that BAC's earnings multiple isn't likely to move much above that level. The bottom line is that if we see continued progress towards lower operating expenditures I think the stock will continue to go up and despite the massive gains for shareholders in the past year, more gains will likely be on deck.

Analysts are currently expecting $1.35 in EPS next year, although estimates vary wildly depending on who you ask. Given that BAC is also expected by many to post a revenue decline next year, operating expenditures are all the more important. Consider what would happen if BAC could save $4 billion in operating expenses next year as a result of New BAC; that equates to 37 cents per share in additional earnings. If management can figure out how to accelerate the benefits accrued from New BAC, which we will hopefully get some clues about during the call and which has already been occurring, huge potential EPS upside is possible. Of course, that operating leverage works both ways which is why I added some cautious commentary around the company's operating expenditures guidance when earnings are released.

The point is that I think the noise surrounding whether or not BAC will grow revenues next year isn't the main metric on which to focus. Of course revenue is vitally important and we will all be waiting with bated breath to hear what management has to say. However, BAC's earnings growth in 2014 is going to come mostly from its ability to execute on New BAC. I posit that the numbers you should focus on are how much money the company is spending to run its business. With such huge savings in the offing, I think BAC could see large upside to analyst forecasts in 2014 with the continued success of New BAC.

Disclosure: I am long BAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.