BNY Mellon: Despite Some Weaknesses Is Still Attractive

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Sep 08, 2014

In this article, let's take a look at The Bank of New York Mellon Corporation (BK, Financial), a $44.66 billion market cap company, which is a leader in securities processing and also provides a range of banking, asset management and other financial services.

Dominant player

The bank is a dominant player in the business of asset custody and servicing. This is a key segment because the bank has focused on scalable, fee-based securities servicing and fiduciary businesses. This way, the company achieved a leading position in most of its major product lines.

This giant focuses on achieving great operating leverage, helped by its strategic acquisitions. It has acquired over 90 businesses over the past decade.

Businesses

Investment services fees were down but investment management revenue was up in the last quarter. Assets under management were up 14%. Further, the bank benefits from competitive advantages in its $1.6 trillion asset management business. So we think it is still attractive, and it is growing faster as the bank expands overseas. Although barriers to entry are relatively low, it is not easy for competitors to build the scale and enter into the market to compete.

Additionally, we have to mention as well, that the recent decision to add retail mutual funds would not generate too much value.

With respect to total staff expenses, they were down 5% and management expects these efforts to have an impact of $120 million annually.

Returning Cash

BNY Mellon said that it plans to focus on organic growth and returning capital to shareholders--dividends plus share buybacks could equal some 90% of earnings in 2014. The company has a strong balance sheet and good cash that allows the company to hike its dividend payout of $0.17 per share, reflecting a dividend yield of 1.63%, lower than the industry average of 3.21%.

Revenues, margins and profitability

Looking at profitability, revenue declined by 6.51% and earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($0.48 vs $0.71). During the past fiscal year, the bank reported lower earnings of $1.74 versus $2.05 in the prior year. This year, Wall Street expects an improvement in earnings ($2.39 versus $1.74).

Net operating cash flow has almost doubled to $3,440.00 million when compared to the same quarter last year. The gross profit margin is currently very high, at 97.92%.

Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

Ticker Company ROE (%)
BK Bank of NY 5.63
BLK BlackRock Inc 11.08
BEN Franklin Resources Inc 21.35
STT State Street Corp 10.48
IVZ Invesco Ltd. 11.2
BX Blackstone Group LP 11.76
 Industry Median 8.2

The company has a current ROE of 5.63% which is lower than the industry median, and it is also lower than its peers. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, Franklin Resources (BEN, Financial) could be the option. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

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Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 17.1x, trading at a discount compared to an average of 20.9x for the industry. To use another metric, its price-to-book ratio of 1.22x indicates a premium versus the industry average of 1.09x while the price-to-sales ratio of 2.99x is above the industry average of 7.29x.

As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $14.502, which represents a 7.8% compound annual growth rate (CAGR).

03May20171401001493838060.png

Final comment

As outlined in the article, the importance of scale is relatively high and benefits the bank towards new competitors.

We imagine a scenario of volatile capital markets with a low interest rate environment, but I feel optimistic on this stock because an increase in revenues would happen when interest rates rise. Moreover, the PE relative valuation makes me feel bullish on this stock.

Hedge fund gurus like Murray Stahl (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), James Barrow (Trades, Portfolio), Bill Nygren (Trades, Portfolio), John Buckingham (Trades, Portfolio), Jean-Marie Eveillard (Trades, Portfolio), Donald Yacktman (Trades, Portfolio) and Mario Gabelli (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.

Disclosure: Omar Venerio holds no position in any stocks mentioned