A couple of weeks ago, I highlighted one big reason why I think Bank of America (BAC) is on its way to $25. In this article, I'll give another reason why I think $25 is only a matter of time as a follow-on to the first.
Bank of America shareholders have been treated to some spectacular gains over the past couple of years and much of that success has come on the back of Project New BAC, the company's cost saving initiative that is redefining the bank since Moynihan took the helm. Part of those cost savings, of course, is in laying off extraneous employees and while nobody wants to see people get laid off, shareholders are reaping the benefits of lower labor expense. In this article, we'll take a different look at how Project New BAC is working by examining the amount of revenue the bank generates from each employee.
To start, I've taken the numbers for the chart below from the company's 10-K filings. I used the number of employees the bank had at the end of each year and I've defined revenue as total interest income plus non-interest income. While that may sound intuitive the bank often reports "revenue" as that which is net of interest expense; I've included all revenue for the total number as it better represents how much revenue is actually being generated, rather than just that which is net of interest expense.
What we see here is pretty interesting. Back when BAC was just a bank, which seems like a very long time ago at this point, revenue per employee grew from $364K to a stagger $573K as the mortgage boom was in full effect. This led to gigantic gains in revenue and profits but as we all know, it didn't end well. 2007 saw the rapid growth arrest abruptly and then dip in 2008 as payroll began to balloon. A bump in 2009 proved to be short-lived and from then until 2012, revenue per employee made a nosedive to $375K, or right where it was in 2004. 2013 then saw a very nice bump to $420K as the bank has turned the corner in terms of combining cost savings with growing revenues.
While this is interesting information, what does it mean for shareholders? I think it has two implications. First, I think it means Project New BAC is showing some legs in terms of its impact in making BAC more productive with the money it spends on labor. Any bank's largest expenditure is going to be labor so it is of the utmost importance that the money that is spent is spent wisely. How do you measure that? I think it's pretty clear that the amount of revenue generate per employee is the best way to gauge exactly how efficient a company is at identifying the best places to invest its money. With BAC having decidedly turned the corner in 2013 in terms of efficiency with its labor investment, I think it means very positive things for BAC's outlook.
With revenue per employee still miles away from its boom-induced high, I think it also shows that the best is yet to come from BAC in terms of revenue generation. One gripe about BAC is that it has seen declining revenue since the crisis, which is a perfectly valid grievance. After peaking at $150 billion in 2009, total revenue came in at $102 billion last year. That is a staggering drop but it was largely on purpose. BAC had, and continues to have, legacy issues from its ill-timed Countrywide and Merrill Lynch purchases and as a result, BAC has been deleveraging and divesting assets and lines of business it no longer wants to compete in. Over the long term, this will prove to be the right move and I think you're already seeing shades of that today. However, in the short term, it causes some pain in terms of total revenue.
This data shows that BAC still has lots of room for improvement in terms of squeezing productivity from its labor force. While 2013 bounced hard off of the bottom, that number is still near the trough of the recent historical range, suggesting there is material potential upside for BAC. The best part for shareholders is that revenue gains on the same labor expense results in higher margins and, all else equal, higher profits. As BAC gains revenue more quickly than it spends on labor, its efficiency ratio drops and profit margins rise. I think the evidence is pretty strong that this is indeed what we'll see from BAC in the coming years as the bank has nearly completed its program to drastically reduce costs and can now focus on growing its business and with it, profit margins.
As a for instance, BAC produced a net profit margin of 11.2% ($11.4 billion in profit on $102 billion in revenue) in 2013. If we assume that revenue per employee increases to $450K in 2014, a relatively modest increase, BAC would produce $109 billion in revenue and, at the same profit margin, $12.2 billion in net income. That would represent 7% earnings growth simply from increased productivity from existing employees. In addition, as revenue per employee increases so does profit margin, as each incremental dollar of revenue gradually produces more net income. Thus, BAC's profit margin would be somewhat higher than 11.2%. Imagine if BAC can get back to $500K+ per employee and what profit margins that would bring. The point is, BAC is still nowhere near its earnings potential and shareholders would do well to continue to hang on, despite the massive gains.