KeyCorp: Now Is A Great Time To Start Looking At This Regional Bank
Summary
- KeyCorp's stock has underperformed the broader market so far in 2018.
- However, KeyCorp is in a great position to benefit from an improving backdrop (i.e., rising rate environment, less-burdensome regulations, and a stronger economy).
- I am long KeyCorp and I plan to stay long through at least 2019.
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KeyCorp (NYSE:KEY) is a regional bank that has been lost in the shuffle so far in 2018, as KEY shares are up only 2% compared to the impressive 9% increase for the S&P 500 (SPY) over the same period of time.
KEY data by YCharts
While I have stayed long KeyCorp over the last few years, I believe that now is a great time for prospective investors to start looking at this underperforming regional bank. Why? It's simple, KeyCorp is a well-run bank that is in a position to benefit from an improving backdrop.
A Promising Backdrop
In my last article on KeyCorp, I described to the Seeking Alpha community why I believed that this regional bank was in a great position to benefit from an improving backdrop. I highlighted the fact that KeyCorp was well-positioned to benefit from (1) a rising rate environment, (2) a rollback of burdensome regulations and (3) an improving economy.
These same benefits hold true even today but it now actually appears more likely that interest rates will be higher sooner rather than later. According to a recent FactSet article, all signs are now pointing toward the Federal Reserve raising rates in its September 2018 meeting (odds of a rate hike at the September 26, 2018 meeting are currently 93.8%, according to FactSet).
Source: FactSet
And, more importantly, the Fed appears to be on a path to continue to raise rates over the next few years.
Source: FactSet
It goes without saying that higher rates bode well for regional banks, which includes KeyCorp. For example, each 25bps increase in the Fed Funds rate results in a net interest income benefit of $4M-$8M per quarter for KeyCorp (not material figures but also not meaningless either).
However, it is very important to note that the prospects of a rising rate environment, an improving regulatory environment, and a strong economy are not the only things going for this bank.
This Is A Well-Run Bank
Investors (and prospective investors) should not only be excited about the prospects of an improving backdrop because KeyCorp's management team has also shown that they are more than capable of running this growing regional bank in any environment. Ms. Beth Mooney, CEO, has transformed KeyCorp from a small unknown bank into a regional powerhouse.
Source: Barclays Global Financial Services Conference 2018
Moreover, the bank's most recent quarterly results show that the transformation is still in full force. On July 19, 2018, KeyCorp reported Q2 2018 results that beat on the top and bottom lines. The bank reported adjusted EPS of $0.44 (beat by $0.02) on revenue of $1.65B (beat by $50M), which also compares favorably to the results reported in the same period of the prior year.
Source: Q2 2018 Earnings Presentation
Highlights from the quarter:
- Adjusted EPS increased by 22% YoY.
- Cash efficiency ratio of 58.8% (down from 59.3% in Q2 2017).
- Strong fee based-business growth - Investment banking and debt placement up $12M (or 8%), and Card and payments income up $9M (or 15%).
- Increased dividend by 14% (dividend is up 42% after factoring in the CCAR results) and repurchased $126M of its shares. Additionally, the bank increased its buyback program to $1.225B, which represents over 5% of the current market cap.
This all sounds good, right? Wait, there is more. KeyCorp is still trading at what I would consider an attractive valuation.
Valuation
When compared to its peer group, KeyCorp is trading at a reasonable valuation based on both a P/TBv and P/Bv basis.
KEY Price to Tangible Book Value data by YCharts
However, based on forward earnings estimates, KeyCorp is trading well below the average P/E ratio.
KEY PE Ratio (Forward) data by YCharts
While KeyCorp is definitely not trading at what I would consider a cheap valuation, it is important to also remember these three points: (1) the bank is still digesting First Niagara so management still has several levers that they can pull to create additional shareholder value, (2) the bank has been extremely shareholder-friendly and will likely continue down this path, and (3) KeyCorp is highly levered to the U.S. economy so it is encouraging that pundits are not calling for a recession at any point in the near future.
Risks
The banking industry has promising prospects in 2018, but a significant downturn in the economy would negatively impact KeyCorp's business. I do not believe that a recession is likely over the next 12-18 months, but things could change quickly.
Integration risk is another important factor that investors should consider for KeyCorp. Management has talked up the First Niagara acquisition so far, and I tend to agree with its assessment of the deal up until this point in time, but there is no guarantee that the acquired assets will be a strategic fit for KeyCorp through 2019 and beyond.
Bottom Line
I believe that the banking industry (especially in the U.S.) has promising prospects as we head into late 2018/early 2019 and KeyCorp is in a great position to benefit from the improving business environment. Investors are already starting to view KeyCorp in a more positive light and, in my opinion, analysts will begin to jump on board if management continues to achieve their financial targets. So, you may want to get out ahead of the herd. As such, I believe that investors with a long-term perspective should treat any pullbacks, especially if they are created by broader market selloffs, as buying opportunities.
Author's Note: I hold a KeyCorp position in the R.I.P. Portfolio.
Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.
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Disclosure: I am/we are long KEY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.