Recently I've been thinking more about Bank of America (BAC), and there are six reasons why I'm starting to like the stock at the current price. Among them are stock buybacks and expense cutting. The buybacks are especially great if the true earnings potential is indeed much higher than current numbers suggest. Brian Moynihan stated that the bank hasn't approached its true earnings potential. To put that statement in some context, I examined historical earnings figures of the bank.
1. Expense cutting
Brian Moynihan repeated it again on the latest Bank of America earnings call:
Another area of our early focus has been rightsizing our expense base. We have been meeting the goals of our cost programs each year. While we've made progress on those each quarter, there is still significant progress when you look over the last couple of years.
After reporting expenses and excluding a goodwill impairment of $77 billion in 2011, we've worked that number down to $69 billion in 2013. As we've been clear with you, we expect additional cost savings in 2014 as we continue to execute on both our new BAC and our legacy assets and servicing initiatives.
The bank has cut about 40,000 employees since 2010. Given that Bank of America needs to integrate several legacy institutions, a number of cutbacks were to be expected. After all, for the acquisitions to make sense, the bank needs to be able to attain some cost savings. At the same time, the bank doesn't have a spotless record for keeping customer service at the highest level. As long as it is done in a sensible way and the bottom line keeps improving, I applaud expense cutting.
2. Retail Operation
Bank of America has a massive deposit franchise in addition to a fleet of Merrill Lynch wealth management offices. This footprint makes the bank highly accessible, and because of the bank's scale, it's able to achieve satisfactory operating results despite this retail footprint.
3. Full Earnings Potential
As already touched upon, the problem of integrating all of the companies that make up Bank of America now are far from solved. While Bank of America is slowly clawing its way back to its former glory, there are still headwinds remaining. According to Moynihan, the bank is making a lot of progress with legacy mortgage issues...
We've also focused on addressing our legacy mortgage issues, and although we still have work to do, we have made progress. On our credit costs and our provision costs, we've seen tremendous results as net loss rates in our portfolios are at levels not seen in nearly a decade.
and Bank of America's CEO is real positive about the true earnings potential of the banking behemoth:
As a result of all this work, earnings have improved significantly, but we still have not approached the true earnings potential of Bank of America. So as we move to slide two, let's talk about recent results in the business on a business by business basis.
One of the strategies Moynihan might push hard is that of cross-selling investment products to its core deposit customer base. Currently, Bank of America manages only a fraction of customers' wealth in investments. By winning over customers to the investment business, profitability of the bank can improve significantly. Shortly after 2008, spending a lot of money to try and accomplish this would have been challenging, but with the current market environment, new highs being recorded on the markets, this is a much more promising endeavor. On the earnings call, the CEO made a few brief remarks:
When you move to our mass affluent customer base, we've seen deepening across the customer relationships. Merrill Lynch Brokers assets continued their strong growth. We've invested heavily in a sales force for what we call our specialist sales force, and that's grown to 6,700 people in 2013.
Looking at what that sales force has been able to do, this year we opened 350,000 new Merrill Lynch accounts, 125,000 new small business deposit and card accounts as well during 2013.
4. Share buybacks
Moynihan talked about the improvements in the balance sheet that were attained and also talked about the share buyback program that management commenced upon:
First, we've improved the balance sheet. Our tier one common capital has grown 16% this year, liquidity and time to required funding have further strengthened. The strength in capital and liquidity allowed us to begin returning capital through share buybacks to shareholders in 2013.
If I'm reading the numbers correctly, the bank reduced shares outstanding by approximately 500 million shares. That is a significant amount and I love it, especially given that the shares are very much undervalued.
5. Discounted cash flow calculation based on historical figures
When I look at historical earnings per share, Bank of America is still a long way of those. Maybe it will never get there. But even if I adjust historical earnings downward because of increased regulation, I still see significant room for earnings to run up. Operational margins are still at depressed levels compared to historical (10 year) numbers and the bank is still in the process of cost cutting. I'm not sure how much time it will take, surely years, but an improvement of 200% in EPS is achievable.
Putting the numbers in a discounted cash flow model, I arrive at a net present value of between $22 and $34 per share. Most likely the most common outcomes are in between these extremes. With Bank of America currently at $17 per share, there is a significant margin of safety with a shot at a double within several years.
6. Relative value
When we compare Bank of America to a basket of more or less comparable competitors, the picture of the bank trading at a discount is further reinforced. Of the six competitors: Wells Fargo Co (WFC), HSBC Holdings (HSBC), Citigroup (C), JPMorgan Chase & Co (JPM), Royal Bank of Canada (RY) and Banco Santander (SAN), only Citigroup, whose CEO I reviewed a short while ago, trades at a comparable level of book value.