The third quarter earnings season has descended upon us. This morning, US Bancorp (USB) and Bank of New York Mellon (BK) reported their third quarter earnings. Both of the above mentioned companies are holdings of Berkshire Hathaway (BRK.A) (BRK.B) which I find particularly interesting. Mr. Buffett seeks out companies that exhibit a sort of competitive advantage in their respective field. He expects the advantage over time to overwhelm its competitors, allowing long term investors to reap outsized gains. The article below will examine the recent earnings release to asses if the competitive advantage is intact and gauge the company's performance.
USB operates as a traditional bank predominantly located in the Midwest portion of the United States. USB reported earnings of 76 cents per diluted share on income of 1,468 million. For comparison the company in 2012 reported earnings of 74 cents per share on income of 1,474 million. The company reduced its share count from 1,880 million at the end of the third quarter in 2012 to a present number of 1,832 million. The share count reduction allowed the company to post higher earnings per share number in spite of a lower net income number.
At first glance, investors are disappointed by the numbers as shares are indicated lower in pre market trading. It is at this point, the patient long term investor has the advantage over the professionals. A further examination of the numbers shows the wonderful franchise that USB has built. I would like to highlight three key metrics that indicate the strength of the franchise.
In my opinion the best metric to evaluate banks is their return on average assets. Most banks will struggle to post a 1% figure. USB return on average assets checks in at a stellar 1.65% similar to Wells Fargo (WFC) and far outpacing rivals such as Northern Trust (NTRS), Comerica (CMA) and Fifth Third Bancorp (OTC:FTIB). In Buffett's view, USB ability to consistently generate a ROA consistently above what its nearest competitors is a competitive advantage that will lead to long term gains.
USB Book Value Per Share data by YCharts
The second metric revolve around book value and the percentage of nonperforming loans. USB is aggressively growing book value with a reported value of $19.31 for the end of the third quarter. This compares favorably with an $18.03 figure for the comparable 3rd quarter of 2012. The growth rate equates to roughly 7 percent, which in my view is a satisfactory number. The amount of nonperforming loans can have a devastating impact on a financial institutions balance sheet. All banks employ leverage to generate their returns. A sharp uptick in nonperforming loans can quickly wipe out a lesser capitalized company's balance sheet leaving the bank insolvent. Thankfully, that isn't the case here with nonperforming loans checking in at 0.95%. This compares favorably with a 1.3% figure for the comparable quarter the previous year.
BK focuses more on asset and wealth management than on traditional banking activities. BK reported net income of 706 million or 60 cents per share which excludes a favorable US tax court ruling. I would like to highlight four key metrics that in my view illustrate the investment case for BK.
The first metric revolves around the company's ability to continue to gather assets. The additional assets managed allow the company to generate interest and fee revenue which drive the bottom line. BK was able to increase assets under management (AUM) by 13 percent as compared to the comparable year ago period. I view this as evidence of strong demand for BK services, which should bode well for future earnings growth.
BK Book Value Per Share data by YCharts
The next three metrics in my view revolve around what I would term "taking care of shareholders". BK managed to repurchase roughly 30.63 million shares which equates to a 2.59% share count reduction. The share reduction exhibited a positive impact on the company's book value allowing it to grow to $30.82 per share for a year over year gain of 2.36%. The takeaway here is BK is trading at roughly book value with the financial community failing to assign a premium for its franchise.
The final metric revolves around the common dividend payout ratio which checked in at 33%. The low payout ratio in my view indicates the company has the financial flexibility to aggressively raise the dividend. I anticipate the company will look to do exactly that in the first half of next year.
In summary both companies performed admirably in the last quarter. For those looking to currently invest in the above mentioned companies, I feel BK is a more compelling opportunity. BK is trading roughly at book value which is far below its pre financial crisis level. The company's payout ratio is also far less than pre crisis levels indicating in my view, outsized dividend hike potential. Its pre crisis norm ranged between 2-3 times book value along with a payout ratio in the mid 40% range. Thank you for reading and I look forward to your comments.