Fifth Third: It's Really Not That Bad Out There

Summary

• Fifth Third's stock has significantly underperformed the broader market so far in 2020.
• The bank reported Q3 2020 results that were actually well-received by the market, unlike most of the other banks that I follow.
• The operating environment for Fifth Third will be challenging through at least the end of 2020, but the backdrop is really not that bad.
• We're long Fifth Third, and we have no plans to reduce our stake in the near future.

Fifth Third's (NASDAQ:FITB) stock has significantly underperformed the broader market over the last year, and it has been pretty much the same story so far in 2020.

Data by YCharts

The COVID-19 (and low interest rate) environment is going to be a significant headwind for Fifth Third, and the other regional banks, through at least the end of 2020 but I think that investors with a time horizon longer than a year or two should seriously consider staying the course.

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The Latest

Fifth Third reported Q3 2020 results that beat on the bottom-line but that fell short of the top-line estimate. The bank reported Q3 2020 adjusted EPS of $0.78 (beat by $0.19) on revenue of $1.9B (missed by $90mm).

Source: Q3 2020 Earnings Press Release

The highlights:

Source: Q3 2020 Earnings Slides

Fifth Third reported strong return metrics (e.g., ROA well-above 1% and ROE above 10.5%) and the bank's net interest margin ("NIM") was actually better-than-expected, unlike many other financial institutions that I follow. Moreover, the bank's credit losses were below management's guidance.

On the other hand, the bank's quarterly results were negatively impacted by several factors (e.g., COVID-19 related expenses & restructuring charge) and management expects for these headwinds to stay in place through at least the end of the current fiscal year. However, any way you slice it, Fifth Third's Q3 2020 results were impressive from almost top to bottom, especially considering the backdrop. Additionally, nothing that I read in the earnings report changed my mind about Fifth Third being a solid long-term investment - as I described in "FITB: It Will (Likely) Take Time For The Story To Play Out", the bulls will likely be rewarded for staying the course through this period of uncertainty.

Looking Ahead, It's Really Not That Bad Out There

The most significant headwind that Fifth Third will face over the next few months will definitely be the prolonged negative economic impact from COVID-19, especially if another stimulus bill is not rolled out in the near[ish] future. However, it is important to note that management is still guiding for a solid finish to 2020, even in a COVID-19 environment.

Source: Q3 2020 Earnings Slides

Plus, it is encouraging that U.S. GDP accelerated at an approximately 33% annualized pace in Q3 2020, which was better-than-expected.

Source: CNBC Report

Additionally, as of October 30, 2020, 64% of the companies in the S&P 500 have reported operating results and approximately 86% of the companies that have reported beat their respective consensus EPS estimate.

Source: FactSet

And notably, the 86% is well-above the five-year average of 73%. Therefore, it is definitely a challenging operating environment almost across the board but, in my opinion, it's not that bad out there. And looking forward, many (if not the majority of) pundits are calling for a recovery in 2021 if a vaccine is discovered/approved.

While management left themselves an out (i.e., communicated during the conference call that the COVID-19 related headwinds could cause additional downward pressure), I would contend that Fifth Third is well-positioned for 2021, regardless of the near term environment.

Pundits have also hung their hats on the low interest rate environment causing further pressure for banks' margins, and rightfully so, but I note that Fifth Third's management team is not sitting idle, with one significant example being the hedges that were put into place.

Source: Q3 2020 Earnings Slides

In addition, management has been aggressively reducing deposit costs in a direct attempt to lessen the negative impact of lower rates on the bank's financial results. There is no doubt that lower rates will be a headwind in the months ahead but, in my opinion, this management team has already taken the necessary steps toward mitigating the interest rate risk to help preserve the bank's margins. More specifically, the bank lowered its interest bearing core deposit rates by 14 bps over the last quarter and expects for a further decline in Q4 2020. This is key as other peers are struggling to contend with this low interest rate environment.

The takeaway: Fifth Third appears to be in a great position to contend with the economic fallout from COVID-19 and the low interest rate environment. It also helps the bull case that FITB shares are attractively valued at today's price.

Valuation

FITB shares are attractively valued based on several of the bank's own historical metrics.

Source: Morningstar

Moreover, the bank is trading at a discount when compared to its peer group based on two key metrics.

Data by YCharts

In my opinion, FITB shares should be trading closer to its book value. I believe that valuation alone is a legitimate reason why Fifth Third shareholders should seriously consider staying the course.

Risks

Regulatory concerns always need to be factored in when evaluating large financial institutions, and this includes Fifth Third. I believe that the regulatory environment has improved, but this could change in short order.

The Federal Reserve and rates are a concern right now, but investors need to also consider the macro environment. A deteriorating economy in 2021 would negatively impact the banking sector. The COVID-19 related impacts should be closely monitored in the months ahead. If the economy is "shut down" again, Fifth Third's stock will likely continue its downward trend.

And the Consumer Financial Protection Bureau filing a lawsuit against Fifth Third for "creating unauthorized accounts" is a potential risk that should be monitored. I believe that it is too early to assign a dollar amount to this risk factor but, in my opinion, this concern could turn out to be a material development in late 2020/early 2021.

Bottom Line

Fifth Third's stock is down for good reasons. The financial sector in general has fallen out of favor, but, in my opinion, this is not a good reason to sell your FITB shares. Instead, I believe that the recent disappointing stock performance is more of a positive than a negative, of course, if you are willing (and able) to hold onto your shares for longer than the next year because this bank still has a strong earnings profile and great long-term business prospects. The bank's Q3 2020 numbers supports this thesis.

I believe that Fifth Third's stock will be a market-beater over the next 18-24 months, so investors with a time horizon longer than the next few quarters should treat any significant pullbacks, especially if they are caused by broader market concerns, as long-term buying opportunities.

Disclosure: I am/we are long FITB. 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.