Fifth Third Will Overcome Challenges To Outperform

| About: Fifth Third (FITB)

On Thursday, Fifth Third Bancorp (NASDAQ:FITB) announced the IPO of its payment processing unit, Vantiv, for $100M worth of Class A common stock. At a time when MasterCard (NYSE:MA) and Visa (NYSE:V) are near their highs, this is indeed an opportune time to create value. And in the years ahead, I anticipate that this asset will be a catalyst for the firm and offer substantial cross-selling opportunities.

With strong 3Q EPS results beating expectations and revisions going up versus down 27 to 1, I believe the fundamentals are strong at a great price. Similarly, KeyCorp (NYSE:KEY), with its wealth management business Victory, also has tremendous cross-selling opportunities, in addition to solid fundamentals. Analysts, however, currently rate only FITB a fair margin above a "hold."

From a multiples perspective, I find that both financials are cheap. While KeyCorp trades at a respective 7x and 9.5x past and forward earnings, FITB trades at a respective 10.4x and 8.5x past and forward earnings. At the same time, FITB offers a dividend yield that is around 100 basis points higher at 2.66%. Since February 2007, FITB lost 69.3% of market value versus 80.9% for KeyCorp.

The major concern for KeyCorp surrounds normalizing earnings, which many investors fear may fall too far below peer levels. I am more optimistic and believe that the corporate bank will continue to do well, as the firm increases its middle market partners and leverages them to strengthen growth in other assets. Moreover, C&I loans have continued to show solid performance - a trend that I expect to continue more in the long-term.

On the other hand, FITB will be challenged by concerns over low interest rates. During the third quarter, the firm performed well largely due to assets repricing slower than liabilities, but this may not continue beyond 2012. In addition, a tough credit market poses additional risks.

At the third-quarter earnings call, CEO Kevin Kabat noted:

Fifth Third reported third quarter net income to common shareholders of $373 million and earnings per share of $0.40. That EPS result was up 14% sequentially and 82% from a year ago. Our return on assets rose to 1.34% and we generated return on tangible common equity of 15%. Additionally, tangible book value per share of $11.05 increased 5% sequentially and 13% from a year ago. It was a pretty strong result especially considering the slow economic growth, low interest rate environment that we're operating in. In fact, this is the highest quarterly net income we've reported since mid-2006, with the exception of the third quarter of '09, when we booked the processing joint venture gain.

Earnings beat the consensus $0.33 EPS, largely due to equity income improvements in Vantiv and improved funding. Solid fundamentals were illustrated in mortgages and commercial loans, while NIM increased to an impressive 3.65%. I anticipate that the loan growth will continue into the fourth quarter, but will be partially offset by more mild returns to deposits.

FITB is a strong bank that derives much of its income from fees. Its flexibility over liabilities make it one of the more safer financials to hold if you are risk-averse to a double-dip. Moreover, management has stressed a commitment to increasing the amount of free cash flow returned to shareholders. Towards this end, the firm has taken the necessary steps to deploy cash in a way that I think will win approval - the PF Tier 1 common ratio rose to 9.8% (Basel III).

Nevertheless, there exists very real regulatory headwinds that could limit profit and impede the firm's ability to expand in the short-term. However, as I stated earlier in a bullish article on JPMorgan (NYSE:JPM), I am of the opinion that many of the regulations will be scaled back in future years - thus offering a political arbitrage opportunity at the present moment.

Consensus estimates for EPS are that it will increase by 90.5% to $1.20 and then by 17.5% and 9.2% in the following two years. Analysts currently rate the stock a "buy." With the stock trading at a low multiple, upcoming capital deployment to create value, and solid fundamentals, I share the bullish sentiment of the Street.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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