Although I am bullish on financials overall, I remain more reserved on regional banks. In particular, Regions Financial (RF) and First Niagara (FNFG) have indicated major headwinds, whether it be strategy acquisition or simple factors outside of their control. While the latter remains attractive on a multiples basis, concerns about low interest rates will hold down value creation from the acquisition of HSBC (HBC) branches.
From a multiples perspective, only First Niagara appears undervalued. It trades at 13x and 8.4x past and forward earnings, while offering a staggering dividend yield of 7.3%. In order to fund the branch buyouts, the company plans on reducing the capital allocation for the first time and at 50%. This actually takes much of the safety out of the investment, and comes at the worst time due to political developments -- more on this below. Regions trades at a respective 24.4x and 8.6x past and forward earnings, while offering a dividend yield of 1%.
At the third quarter earnings call, First Niagara's CEO, John Koelmel, noted the firm's vulnerability to political and economic developments:
"And today in my view, the entire industry is on a much more slippery slope than it was three years ago, maybe better positioned in total to weather the storm, but navigating this one will be much trickier and more challenging for all of us. Sectors definitely in for a real bumpy ride for a while, and that’s hard for me acknowledge, we are always in the glasses more than half full camp, but the reality of the continuing political regulatory and economic dysfunction is impossible to ignore and that gets me to the Fed.
The August 9 announcement to put a stake in the ground to keep rates low through at least mid ‘13 coupled with operation Twist clearly has had dramatic impacts on the industry. Overnight literally the landscape changed. Most importantly through investors in our sector into a tailspin and we have been running through or hiding in the hills ever since and obviously look at all of us in a dramatically different way compared to what’s literal as 90 days ago".
Challenges in growing loans organically has resulted in the firm pushing for the second best alternative: growth through accretion, hence the HSBC acquisitions. Unfortunately, the benefits derived from the HSBC branch acquisitions will be lower than expected, since interest rates have become less favorable. In addition, the Fed's Operation Twist will have the effect of limiting yields and adding considerable risk to investments.
Consensus estimates for First Niagara's EPS are that it will grow by 13.8% to $0.99 and then by 4% and 16.5% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS of $1.01, the rough intrinsic value of the stock is $14.14. This implies an upside of 62% and renders the company a value play, albeit a risky one. Uncertainty in the economic and political environment is not for the faint of heart.
Regions, on the other hand, is struggling more with strategy acquisition. Failure to sell Morgan Keegan has disappointed investors and raises concerns about projected financial standing. The firm should consider raising common stock and using the proceeds to pay back net debt in order to de-risk the business. Although I believe that the firm will pay off TARP quicker than expected, a weak business environment in the short-term will hold back value creation.
Consensus estimates for Regions' EPS are that it will turn positive at $0.17 in 2011 and then grow by triple and double digits in the following two years. Assuming a multiple of 15x and a conservative 2012 EPS of $0.41, the rough intrinsic value of the stock is $0.41. Again, due to macro instability, risk-averse investors are advised to look elsewhere.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
