Huntington Bancshares: Limited Growth But Solid Income Potential

Geoff Considine profile picture
Geoff Considine
4.94K Followers

Summary

  • As expected, HBAN earnings dropped following the merger with TCF.
  • The long-term growth outlook is muted, but the share price is quite low relative to current earnings.
  • The Wall Street consensus rating is bullish, with expected 12-month total return of about 30%.
  • The market-implied outlook (calculated from options prices) is neutral.
  • With the 4.6% dividend yield and fairly expensive call options (due to elevated market volatility), a covered call strategy provides considerable income.

Huntington Bank, Cleveland, Ohio

RiverNorthPhotography/iStock Unreleased via Getty Images

Huntington Bancshares (NASDAQ:HBAN) is in the early stages of integrating TCF Bank, which HBAN merged with, closing June in 2021. Since the merger was completed, the shares have fallen, with a trailing 12-month total return of -11.6%. This decline has much less to do with HBAN specifically than the negative trend for banks. The regional banking sector, as defined by Morningstar, has a total return of -11.1% over the same period. The SPDR S&P Regional Banking ETF (KRE) has returned a total of -11% over the past year.

HBAN stock price chart

Seeking Alpha

12-Month price history and basic statistics for HBAN (Source: Seeking Alpha)

In general, rising interest rates are positive for banks and other financial firms that generate a substantial portion of their revenue from interest. In April, HBAN management raised net interest income guidance based on an expectation of persistence in rising interest rates.

Goldman Sachs recently selected HBAN as a top pick for dividend yield and growth. HBAN has a current yield of 4.6% and the 3- and 5-year dividend growth rates are 4.8% and 15.3% per year, respectively. The payout ratio is currently higher than one would like, at 71.8%.

Huntington Bancshares earnings history

ETrade

Trailing and estimated future quarterly EPS for HBAN. Green (red) values are amount by which quarterly EPS beat (missed) the consensus expected value (Source: ETrade)

HBAN reported a net loss for Q2 of 2021 because of costs related to the merger. Earnings have recovered steadily in the most-recent 3 quarters, albeit slightly slower than the consensus outlook projected. The consensus outlook for longer-term earnings growth is a concern, with expected EPS growth of only 2% per year over the next 3 to 5 years.

I last wrote about HBAN on May 22, 2021, prior to the completion of the merger with TCF, and I assigned a buy rating. The fundamentals looked reasonable, especially relative to the prevailing valuations across the market. The forward P/E was 10.8 and the forward dividend yield was 3.9%. In looking at HBAN, I relied on two forms of consensus outlooks. The first was the well-known Wall Street analyst consensus rating (bullish) and 12-month price target (about 9% above the share price at that time). The second was the market-implied outlook, which represents the consensus view from the options market. The market-implied outlook was slightly bullish.

Huntington Bancshares article

Seeking Alpha

Previous analysis of HBAN and subsequent performance vs. the S&P 500 (Source: Seeking Alpha)

Since this post, HBAN has returned a total of -13.0% vs. -4% for the S&P 500 (SPY) and -12.4% for the SPDR Regional Bank ETF.

For readers who are not familiar with the market-implied outlook, a brief explanation is needed. The price of an option on a stock reflects the market’s consensus estimate of the probability that the share price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of call and put options at a range of strike prices, it is possible to calculate a probabilistic price forecast that reconciles the options prices. This is the market-implied outlook and represents the consensus view implied by the options prices. For a detailed reference on this topic, I recommend this monograph published by the CFA Institute.

In this article, I discuss a transaction that I executed on the day that I wrote the article, buying HBAN for $15.72 and selling call options with a strike price of $17, expiring on January 21, 2022, for $0.778. Selling the covered calls provided an option premium income yield of 4.95% ($0.778/$15.72) over the next 8 months. This option premium income, assuming the call options were not exercised because the options expired out of the money, raised the total return to -8.1% (4.95%+13.02%).

With a year since my last analysis of HBAN, I am revisiting my rating. I have calculated the market-implied outlook to January 20, 2023, and I have compared this with the current Wall Street consensus outlook, as in my previous post.

Wall Street Consensus Outlook for HBAN

ETrade calculates the Wall Street consensus outlook by combining the views of 11 ranked analysts who have published ratings and price targets over the past 3 months. The consensus rating is neutral and the consensus 12-month price target is 26.7% above the current share price.

HBAN Stock Wall Street consensus outlook

ETrade

Wall Street consensus rating and 12-month price target for HBAN (Source: ETrade)

Seeking Alpha’s version of the Wall Street consensus is based on ratings and price targets from 19 analysts who have published their opinions in the past 90 days. The consensus rating is bullish and the consensus 12-month price target is 27.9% above the current share price.

HBAN stock Wall Street consensus outlook

Seeking Alpha

Wall Street consensus rating and 12-month price target for HBAN (Source: Seeking Alpha)

One difference between these two versions of the Wall Street consensus is that ETrade’s consensus rating, calculated using ranked analysts, went neutral from late 2021 to early 2022, as the share price spiked upwards.

Market-Implied Outlook for HBAN

I have calculated the market-implied outlook for HBAN for the 8.1-month period from now until January 20, 2023, using the price of call and put options that expire on this date. I used this expiration date to provide a view through the end of 2022 and because the January options tend to be among the most liquid. The options trading on HBAN is light overall, which reduces the weight that I put on the market-implied outlook in my overall evaluation.

The standard presentation of the market-implied is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

market-implied outlook for HBAN

Geoff Considine

Market-implied price return probabilities for the 8.1-month period from now until January 20, 2023 (Source: Author’s calculations using options quotes from ETrade)

The market-implied outlook to January 20, 2023 is generally symmetric, with comparable probabilities of positive and negative returns of the same size, although the peak in probabilities is slightly shifted to favor negative returns over this period. The expected volatility calculated from this outlook is 34% (annualized).

To make it easier to directly compare the relative probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).

HBAN stock market-implied outlook

Geoff Considine

Market-implied price return probabilities for the 8.1-month period from now until January 20, 2023. The negative return side of the distribution has been rotated about the vertical axis (Source: Author’s calculations using options quotes from ETrade)

This view shows that the probabilities of negative returns are consistently, albeit modestly, higher than the probabilities of positive returns, across the majority of possible outcomes (the dashed red line is above the solid blue line across almost all of the chart above).

Theory suggests that the market-implied outlook should have a negative bias because investors, in aggregate, are risk averse and thus tend to pay more than fair value for downside protection (e.g., put options). There is no way to measure whether such a bias is present, however. Because of the expectation for some negative bias, I interpret this market-implied outlook as neutral, perhaps with a slight bearish tilt.

During trading hours today, I bought shares of HBAN for $13.21 and sold call options with a $14 strike price, expiring on January 20, 2023, for $0.81. This translates to 6.1% in option premium yield over the next 8.1 months. This position is expected to pay out $0.465 in dividends (3 out of 4 annual payments) between now and when the option expires, for a total income yield of 9.65% over 8.1 months (14.3% annualized).

Summary

Mergers make it hard to predict earnings because the ultimate costs of bringing two companies together are often higher than expected and the timelines are difficult to estimate. That said, the merger of TCF and Huntington Bancshares appears to be going smoothly, albeit with a slightly higher drag on earnings than expected. The outlook for earnings growth over the next 3 to 5 years is uninspiring, but the Wall Street consensus outlook is bullish and the consensus 12-month price target is about 27% above the current share price. Combined with the 4.6% dividend yield, this puts the expected total return above 30%. Given the current market conditions, the consensus price target seems optimistic. As a rule of thumb for a buy rating, I want to see an expected 12-month total return that is at least ½ the expected volatility (which is 34%). Even giving the consensus price target a significant haircut, HBAN surpasses this threshold. The market-implied outlook to early 2023 is predominantly neutral. While the growth outlook for HBAN is fairly poor, the shares are trading at a substantial discount from a year ago, in an environment that looks pretty for the company. I am maintaining my buy / bullish rating on HBAN, although I have sold covered calls against my holdings, not least to buffer the muted growth outlook.

This article was written by

Geoff Considine profile picture
4.94K Followers
Geoff has worked in quantitative finance for more than twenty years. Before entering finance, Geoff was a research scientist for NASA. Geoff holds a PhD in Atmospheric Science from the University of Colorado - Boulder and a BS in Physics from Georgia Tech. Neither Geoff Considine nor Quantext (Geoff's company) are investment advisors. Nothing in any commentary here on Seeking Alpha or elsewhere shall be regarded as advice.
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Disclosure: I/we have a beneficial long position in the shares of HBAN either through stock ownership, options, or other derivatives. 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.

Additional disclosure: I have sold covered calls as described in the post.

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