Revisiting The Bank Of New York Mellon

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About: The Bank of New York Mellon Corporation (BK)
by: Dalton Hicks
Summary

BK posted strong results in key metrics amidst a rough 1Q19 on a YOY basis.

BK has demonstrated strong commitment to its shareholders via dividends and share repurchases.

Evaluating why BK had a rough 1Q19, trade war fears, and why I believe BK's struggles are only temporary.

Looking at BK's quantitative fundamentals, how they show that BK is undervalued, and providing a 12-month price target.

Thesis:

I wrote an analysis on the Bank of New York Mellon (BK) back in February of this year iterating quite an optimistic 12-month price target of $64.00 per share. At the time, I cited the expectation of rising interest rates, financial stability, and BK's commitment to its shareholders as my reasons for said optimistic outlook. While BK had a relatively rough 1Q19 in terms of a YOY basis, I am still iterating my optimism towards BK moving forward. The Bank of New York Mellon's financial metrics indicate that the company is undervalued, it's committed to its shareholders, and I believe current economic conditions will improve along with U.S./Chinese trade war resolution.

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Impressive Financial Metrics amidst Rough 1Q19 YOY Performance:

The Bank of New York Mellon had a rough first quarter, witnessing its net income decline 20% from 1Q18. In fact, BK experienced losses in all of its segments except one, Clearance and Collateral, which saw 8% YOY growth from 1Q18. With that being said, BK posted strong results in what my opinion are overlooked areas by many investors.

The Bank of New York Mellon posted strong figures in both its return on common equity and its return on tangible common equity in 1Q19. Its return on common equity was 10% and its return on tangible common equity was 20.7%. Whiles these figures are respectively lower than those posted in 1Q18, they are still indicative of a strong company with growth potential, as its growing shareholder equity at a double-digit rate.

My personal favorite is BK's 1Q19 book value per share of $39.36. With a current market price of $43.03 per share, that means BK is trading approximately 9.3% higher than its book value per share. While I know Warren Buffett has stated that only repurchasing Berkshire shares at 1.2x book value or cheap is no longer a viable method of valuing Berkshire, I do believe Warren would love to be able to buyback Berkshire or even a strong company like BK for under 1.2x book value.

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The Bank of New York Mellon has grown EPS, dividends, book value per share, net income, and more at impressive rates for years. In the midst of a rocky business environment, BK has still produced impressive results. The fact that BK is growing shareholder equity at double-digit rates and is trading at less than 1.2x its book value should be enough in itself to gain the attention of any investor. BK is undervalued just in the sense that it is currently trading at only 1.09x its book value.

Commitment to Shareholders:

The Bank of New York Mellon has demonstrated its commitment to its shareholders with a fair dividend yield, its consistent share repurchase program, and the fact that it has grown its dividend for six years straight now. BK currently provides a 2.58% dividend yield with an annualized payout of $1.12 per share, and a payout ratio of 26.8%. In 1Q19 BK bought back $555 million worth of shares and paid out $270 million in dividends, totaling $825 million returned to shareholders in 1Q19. The Bank of New York Mellon also announced that it will be increasing its quarterly dividend starting 3Q19 by 11% to $0.31 per share. BK is also planning on repurchasing $3.9 billion worth of shares over the next year, roughly 20% more than the $3.3 billion the company projected to repurchase this year in 2018. Providing a consistent dividend and large share repurchase programs are reassuring in the fact that BK is committed to returning capital to the shareholders while simultaneously creating more shareholder equity.

Why BK Had a Rough 1Q19:

To begin, in my previous analysis covering BK I cited forecasts of rising interest rates as one of my points of optimism surrounding BK. However, the Fed just recently voted to keep the benchmark rate range between 2.25% - 2.50%. Previously rate hikes were anticipated, however, not only did a rate hike not occur, but now rate cuts seem to be in the talks moving forward. I cited rising interest rates as a positive in terms of looking at interest income, however, BK makes the majority of its revenue from its investment services. BK's investment services is broken down into its respective segments in the graphic below.

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As seen in the graphic above, BK experienced sizeable losses in its Asset Servicing, Pershing, and Issuer Services segments, all which would fall under BK's investment services. In Asset Servicing we can see deposit balances and client activity marked as negative. In Pershing we see transaction volumes, long-term mutual fund assets, and previously lost business marked as negative. Issuer Services also has deposit balances marked as negative. The point I'm making here is that it's clear BK's struggles are a result of investors pulling out of markets due to trade war fears with China.

Between various economic indicators foreshadowing a potential recession along with trade war fears with China, many investors have started pulling out of markets in hopes to protect their capital. Read this article discussing the spread in the Treasury yield curve and how it's an economic indicator of a potential recession moving forward, as well as how the trade war fears with China have impacted the market and the Federal Reserve's newfound likelihood to cut interest rates moving forward. So long as trade war fears with China exist, I believe the U.S. economy will continue to tighten up. BK's losses in its largest revenue generating segments are a result of lower deposit balances, client activity, transaction volumes, and long-term mutual fund assets, which are essentially all directly associated with investors pulling their capital out of the markets.

Why Stabilizing Market Conditions Make BK a Considerable Investment:

BK isn't losing clients, deposits, transactions, etc. because it's performing poorly as a business, it is losing that business because investors just simply can't afford to risk investments and savings in what is conceivably a volatile market. I believe company's become undervalued during temporary times of crisis, which is the time to capitalize on an investment. BK is a strong business, and I do believe it will regain the losses it experienced in 1Q19, as well as losses it may incur in 2Q19 or 3Q19, once economic conditions and trade war fears with China stabilize. While I know there's the big 'if' on whether or not the U.S. and China will come to an agreement, however, I feel confident an agreement will be made. Both the U.S. and China know a trade war between the two would essentially lead to a global recession. In 2019 the global GDP will be over $87 trillion. Cumulatively the U.S. and China cultivate $35.5 trillion, or roughly 40% of the global GDP. Both countries face astronomical losses amongst a trade war with a ton to gain from a fair agreement on the other hand. In all, I'd say it is more likely than not that an agreement between the U.S. and China will be made.

Strong Quantitative Fundamentals:

BK managed to post reasonable 1Q19 results all things considered. I am particularly fond of the fact that BK has managed to growth shareholder equity at double-digit rates even when market conditions aren't favorable. With interest rates now supposedly expected to be cut, and with a U.S./Chinese trade agreement, I without a doubt believe that BK will continue to produce the outstanding results for its investors that it previously was. To be clear on what I mean by that, BK has grown its net income as a CAGR of just over 13.5% since 2014. It has grown its EPS at a CAGR of just over 17% and free cash flow at a CAGR of just over 7% since 2014 as well. Additionally, as stated previously, BK is also currently trading at only 1.09x its book value per share.

Looking further, BK is currently trading at 11.2x its trailing 12-month EPS of $3.87. The average P/E ratio in the investment services sector is 13.06 with an average P/B ratio of 1.54. According to NASDAQ, BK is forecasted to earn $3.99 per share for FY19, putting them $0.05 behind FY18's EPS. However, BK is 16.6% undervalued compared to its peers on an earnings multiple basis, and it's 41.3% undervalued compared to its peers on a price-to-book ratio basis. In this case I am going to take the average of the two figures, implying BK is undervalued by roughly 29% holistically when compared to its peers when looking at earnings multiples and price-to-book ratios.

The Bank of New York Mellon is also quite financially sound, sitting with a CET1 Ratio of 11% along with and SLR of 6.3%. BK has plenty of capital on hand and is plenty well-leveraged against its risk-weighted assets.

Associated Risks:

In all, I feel like I actually addressed a lot of the risks associated with the Bank of New York Mellon in previous paragraphs. At least from my perspective, I find the main concerns with BK to be surrounding current economic turmoil in relation to trade war fears. BK has seen hits in its investment services, and is a direct result of investors pulling capital out of markets out of fear. Fundamentally BK is strong, however, if a trade war takes place, BK will feel the repercussions along with enterprises worldwide. Other than the happening of a trade war, I personally find BK to be a fundamentally secure investment.

Conclusion:

In conclusion, the Bank of New York Mellon appears to be a strong, undervalued company to me. It has demonstrated success growing nearly all of its key metrics at double-digit rates for consecutive years, and is undervalued on both an earnings multiple and price-to-book ratio basis in comparison to its peers. BK provides a solid dividend that has demonstrated consistent growth and is still growing. BK also managed to post what in my opinion were quite favorable 1Q19 results when considering market conditions. With the biggest of BK's troubles being a cold trade war that I believe will resolve in due time, I find BK to be quite an enticing investment option. Based on the analysis above and figures in my quantitative fundamentals paragraph, I do believe that BK is quite undervalued. Due to tighter market conditions, I am iterating a lower but still optimistic 12-month price target of $56.00 per share, representing approximately 29% 12-month upside potential with shares purchased at the current market price around $43.40 per share.

Disclosure: I am/we are long BK. 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.