KeyCorp: Mixed Q3 2018 Results, But The Stock Has One Near-Term Catalyst

Summary

• KeyCorp reported Q3 2018 results that were not well-received by the market.
• The bank's growing dividend (and capital return plan) may be the only near-term catalyst for the stock.
• I am long KeyCorp and may build the position over the next few quarters.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Start your free trial today »

KeyCorp (NYSE:KEY) recently reported Q3 2018 financial results that were not well-received by the market, as shown by the almost 6% decline in the stock price over the last five days. On an YTD basis, KEY shares have significantly underperformed the broader market.

KEY data by YCharts

It was hard to find many positive takeaways from KeyCorp's most recent results, but in my opinion, this regional bank will be able to bounce back. The dividend may be the only thing going for this bank for the time being, of course, besides an improving backdrop that should help management get the company back on track.

The Near-Term Catalyst, The Dividend

KeyCorp has long been a shareholder-friendly company, and I do not expect for this to change anytime soon. The most recent example of management showing its commitment to shareholders was the over 40% increase in the bank's dividend.

Source: Fidelity

Looking back, KeyCorp has a 5-year dividend growth rate of over 25% and, more importantly, the bank still has the wiggle room to grow it in the years ahead. It should also be noted that the bank repurchased approximately $540M worth of its stock during Q3 2018 and still has a sizable amount of dry powder to deploy over the next few quarters (the board recently approved a $1.2B, or approximately 6% of the bank's total market cap, buyback program). The buyback is important especially as the shares decline in value.

Therefore, while the Q3 2018 results were nothing to brag about, I believe that KeyCorp's capital return plan is enough to buy management some time, at least over the next quarter or two.

The Q3 2018 Results, Nothing To Brag About

On October 18, 2018, KeyCorp reported in line Q3 2018 earnings, but the top-line missed the consensus estimate. The bank reported Q3 2018 adjusted EPS of $0.45 on revenue of $1.6B (missed by $40M).

The following were the highlights from the quarter:

• Adjusted EPS was up 41% YoY, which was largely a result of improving business results and the positive benefits of tax reform
• Return on average total assets was up 33% YoY
• Average loans and deposits were both up 2% YoY
• Noninterest expenses were down 3% YoY (to $964M), and noninterest income was up 17% YoY (to $609M)

All sounds good, right? The market, however, did not like: (1) KeyCorp's lower-than-expected loan growth, (2) lackluster fee-based income results, and (3) the bank's top-line miss.

For Q3 2018, KeyCorp reported 2% YoY average loan growth, but the average loan balance was lower than the prior quarter.

Management downplayed the growth, or lack thereof, and mentioned that the quarterly results were actually improving as the quarter progressed. Moreover, management guided for low-single-digit loan growth for the last quarter of 2018.

In relation to fee-based income, management reiterated during the conference call that the underlying trends for these businesses remained strong but that there was a lot of noise in the numbers for Q3 2018.

As shown, a gain from the sale of its insurance business in Q2 2018 was a major contributor to the QoQ decline. Anyhow, the market (including myself) expected for KeyCorp to report better fee-based income results, so management has a lot to prove in Q4 2018.

Lastly, for revenue in general, I believe that this exchange between management and an analyst during the conference call really summed up the top-line miss:

Matt O'Connor [Deutsche Bank]

Okay, that's helpful. Just stepping back, kind of bigger picture, revenue overall, I feel like was soft this quarter. Some of it seems like it's temporary, and obviously you've addressed some of the pieces with loans and fees. But just kind of big picture, do you think this was a quarter where things just kind of went against you from a revenue perspective, or do you think the revenue outlook is going to be a little bit weaker than you would have thought and maybe you should be focused on tightening in the costs a little bit more?

Don Kimble

I would say that loan balances have come in lower than what we would have expected for the third quarter, and that really was the surprise that we had at the end of the second quarter, which continued for us, which was the lower levels of utilization and the impact from some higher pay downs. So as we would have come into this year, we would have expected loan growth to pick up in the second half of the year and we haven't seen that, and so that is a surprise for us based on what our expectations would have been coming into the year.

As far as the fee income categories, when we look at the activity and the volumes and the customer activity around these areas, we're seeing positive trends, and so our guidance for the fourth quarter says that fee income should be up mid single digits on a linked quarter basis, so I think we're going to see some of that momentum come in the fourth quarter and, I think, help set the table for us going forward.

You know, the follow-on point that you made, Matt, it's something we always do manage to, and if the revenue growth isn't there, then we do believe that it's important that we do manage our expenses more tightly, and that's something that we'll continue to look at and make sure that we're doing what we need to do to make sure that we live up to our commitments.

Beth Mooney

Matt, this is Beth. We're obviously in the 2019 planning cycle and it is very much focused as we have, both Don and I, reiterated the commitment to the 54 to 56% efficiency ratio target, and that we plan to be operating within that by the back half of 2019. We are making sure we are constructively balancing both our outlook for revenue as well as appropriate expense levels and investments in order to achieve that.

Simply put, it was a tough quarter for KeyCorp, and management would be the first to tell you that. However, it appears that Ms. Beth Mooney, CEO, and team have plans in place to get this regional bank back on track.

Valuation

KeyCorp's stock is trading at attractive valuations when compared to its peer group.

KEY Price to Tangible Book Value data by YCharts

However, given KeyCorp's mixed Q3 2018 results, I expect for the stock to remain under pressure through at least the remainder of 2018. Therefore, investors may be able to pick up shares at more attractive levels over the next few months.

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

KeyCorp is a well-run company and, as I previously described here, I believe that the bank is operating in an improving backdrop (i.e., rising rates, less-burdensome regulations, and strong economy). The bank's capital return plans should create a floor for the stock so investors that are willing (and able) to hold onto shares for the next three to five years should view significant pullbacks as long-term buying opportunities.

Author's Note: All images were taken from KeyCorp's Q3 2018 Earnings Presentation, unless otherwise noted. I hold a small KeyCorp position in the R.I.P. Portfolio and I may add KEY shares in the near future.

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.

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.