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Summary

  • BB&T reported a tough second quarter and shares have sold off.
  • Sentiment is very low right now despite a recent analyst upgrade.
  • Valuation combined with a strong dividend make shares a buy here.

BB&T (NYSE:BBT) is a large regional bank based in North Carolina. The company has a significant branch presence in its markets and has a reputation for being a large "traditional" bank providing deposit and loan products along with investment advice and trust services. While BBT is involved in capital markets activity, it isn't what you would think of as a Wall Street bank like the four mega banks; BBT is in the business of taking in deposits and making loans. In the past, this model has worked very well for BBT and investors have seen gains with a relatively small amount of volatility. After the company reported a rough Q2, shares sold off pretty sharply. In this article, we'll take a look at BBT shares to see if they are a buy after the selloff.

To do this, I'll use a DCF-type model that you can read more about here. Basically, the model takes inputs like earnings, which I've sourced from Yahoo!; dividends, which are my own estimation; and a discount rate, which I've set at the 10-year Treasury rate plus a risk premium of 6.5%. It is important to note that all of the assumptions are open to interpretation and that your estimates may not look like mine.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$2.89

$2.79

$3.14

$3.31

$3.48

$3.67

x(1+Forecasted earnings growth)

-3.50%

12.50%

5.35%

5.35%

5.35%

5.35%

=Forecasted earnings per share

$2.79

$3.14

$3.31

$3.48

$3.67

$3.86

Equity Book Value Forecasts

Equity book value at beginning of year

$29.57

$31.40

$33.50

$35.69

$37.96

$40.32

Earnings per share

$2.79

$3.14

$3.31

$3.48

$3.67

$3.86

-Dividends per share

$0.96

$1.04

$1.12

$1.21

$1.31

$1.41

=Equity book value at EOY

$29.57

$31.40

$33.50

$35.69

$37.96

$40.32

$42.77

Abnormal earnings

Equity book value at begin of year

$29.57

$31.40

$33.50

$35.69

$37.96

$40.32

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

$2.66

$2.83

$3.01

$3.21

$3.42

$3.63

Forecasted EPS

$2.79

$3.14

$3.31

$3.48

$3.67

$3.86

-Normal earnings

$2.66

$2.83

$3.01

$3.21

$3.42

$3.63

=Abnormal earnings

$0.13

$0.31

$0.29

$0.27

$0.25

$0.24

Valuation

Future abnormal earnings

$0.13

$0.31

$0.29

$0.27

$0.25

$0.24

x discount factor(0.09)

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

$0.12

$0.26

$0.22

$0.19

$0.16

$0.14

Abnormal earnings in year +6

$0.24

Assumed long-term growth rate

3.00%

Value of terminal year

$3.93

Estimated share price

Sum of discounted AE over horizon

$0.96

+PV of terminal year AE

$2.34

=PV of all AE

$3.30

+Current equity book value

$29.57

=Estimated current share price

$32.87

As we can see, the model produces a fair value of about $33 for BBT shares, or around $3 less than shares trade for as I write this. That would indicate BBT shares are slightly overvalued at present but before we make any decisions, we must understand what the model is telling us.

The model is computing a fair value based upon the inputs I described above; it is not computing a target price. This is an important distinction as a target price would be somewhat higher based upon your outlook. The model is basically saying BBT shares are worth $33 today based upon the risk I assigned them via the discount rate and the amount of earnings the company is expected to show in relation to its book value. Thus, the model is saying BBT's return on assets isn't going to be high enough to justify $36. However, in the case of BBT, I think there is more at play here.

The second-quarter report wasn't good. Revenue fell 7.5% YoY as the mortgage business, BBT's bread and butter, was exceptionally weak. This caused the company to miss on the top and bottom lines for the quarter and shares were sent off a cliff, as you can see in the chart below. In addition, net interest margins ticked lower by 9 basis points due to lower rates secured on new loans. On the bright side, BBT increased its loan portfolio slightly but overall, this was not a good quarter and shares reflected that. However, this has happened before and it will happen again, but all is not lost.

Recently, Wells Fargo's (NYSE:WFC) analyst upgraded BB&T on a valuation basis and the high quality of its loan portfolio. I mentioned that BBT is a traditional bank and that means its loan book is its primary source of revenue. It sounds simple but some banks do not operate that way; BBT has forever and I suspect it always will. BBT has always been exceptional at managing credit quality and risk and that hasn't changed. WFC reckons BBT shares are cheap and recommends buying them, but curiously, shares didn't move up on the upgrade. In fact, they trade for less than they did when the upgrade was announced two days ago. In other words, I think sentiment is quite low on BBT right now, which could present an opportunity for entry into a long-term position in the stock.

BBT's business is solid and while the drop in mortgage revenue is concerning, mortgages are a cyclical beast and no one should be surprised when things don't go perfectly each quarter. However, there is another reason I think BBT might be worth a look here. If we look at the chart below, we see an interesting development.

(click to enlarge)

Shares are currently at pretty decent support at the $36 level. This is a level that shares have bounced off of twice in 2014 alone and it will be very interesting to see if they bounce again this time. If we see shares bounce, they could go back into the $40 area but if not, we could be looking at $32 in the near future. Time will tell but unless proven otherwise, I think we'll see shares bounce off of the $36 area.

I'm doing something I normally don't do and that is to go against what my model is telling me. The model says shares are slightly expensive right now but given sentiment is so poor, the decent dividend the shares pay and the support we are trading at right now, I think BBT shares are a buy here. The good news is that if I am wrong there is very strong support at $32 to $33 both from a technical perspective and a fundamental perspective. BBT would be very cheap at those levels and would be yielding almost three percent. But given the oversold condition we find shares in today, I think BBT is worth a look right now. And in addition to that, we're only at ~11 times next year's earnings so despite BBT's muted earnings growth rate, shares are pricing in very little growth, leaving some room for an upside surprise or two.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in BBT over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: BB&T: An Income Stock For The Risk Averse