Since I first presented a more bullish case on BNY Mellon (BK) than the Street here, the stock has risen by 18%, beating the Dow Jones by 870 basis points. This is particularly remarkable in light of the negative impact arising from the Fed announcing that it will be keeping interest rates low until 2014. The Street has accordingly reduced EPS targets significantly. In any event, I continue to see upside for both BNY Mellon and competitor State Street (STT).
From a multiples perspective, BNY Mellon is the cheaper of the two. It trades at a respective 10.9x and 8.7x past and forward earnings while State Street trades at a respective 11.2x and 9.5x past and forward earnings. In addition, BNY Mellon has a dividend yield that is 70 bps higher at 2.4%. Even still, the firm is rated a "hold" versus a "buy" for State Street.
At the fourth quarter earnings call, BNY Mellon's CEO, Gerald Hassell, noted poor results:
Obviously, it was a tough revenue quarter as our results reflected the ongoing macro environment challenges. The general uncertainty in the financial markets resulted in lower-than-normal levels of client activity. Now a good indicator of that is the combined share volume on the New York Stock Exchange and NASDAQ, which was down 6% year-over-year and 18% sequentially. It clearly has an impact on areas like our investment services fee revenues.
Investors have been very risk averse. We saw a lack of organic growth as our clients reallocated their assets in a more defensive posture, significantly to cash, in response to uncertainty in the markets. Money market fund managers, including our own, have been particularly conservative. They shortened durations and reduced European exposure, which resulted in lower yields and even higher money market fee fund waivers.
With increasing financial regulations, however, BNY Mellon will benefit from greater demand for outsourcing. Globalization will further create economic value by specializing firms like BNY Mellon in back-office work. BNY Mellon has the operating scale and brand that will attract clients. During the fourth quarter, low interest rates constrained NIM, limiting the benefits from the 8% rise in net interest income. And even though the company grew assets under custody, fees generated by 3%. The 1.5% decline in operating costs was also disappointing, but this can be easily improved off of and thus should be viewed as more of a catalyst.
Consensus estimates for BNY Mellon's EPS forecast that it will grow by 10.3% to $2.24 in 2012 and then by 12.1% and 10.8% in the following two years. Of the 21 revisions to estimates, 17 fell for a net change of -3.9%. Assuming a multiple of 11x and a conservative 2013 EPS of $2.45, the rough intrinsic value of the stock is $26.95, implying 22.8% upside.
State Street similarly had poor finish to the year. Clients sought to de-risk as a result of low-interest rates and management continued to struggling in mitigating the cost base. Going forward, State Street will be attractive due to its strength in integrating assets and lack of vulnerability in spread income. Management would be wise, however, to focus more on improving the balance sheet than taking over divested foreign bank assets - a second priority.
Consensus estimates for State Street's EPS forecast that it will grow by 4.6% to $3.90 in 2012 and then by 14.6% and 15.4% in the following tow years. Assuming a multiple of 11x and a conservative 2013 EPS of $4.38, the rough intrinsic value of the stock is $48.18, implying 13.2% upside.