Bank Of America Still Has The Credentials To Outperform

I’ve liked Bank of America (NYSE:BAC) (“B of A”) for over a year now, and while regional banks have lived up to my expectation of outperformance versus the money center banks, Bank of America has still done well on a relative basis – and “relative” is an important caveat here, as bank stocks have taken some hits this year despite the prospect of strong earnings growth in 2023. Since my last update, the shares have beaten large bank peers by about 10%, and have outperformed them by about 5% this year.

I continue to like this bank’s blended exposure to both money center banking and Main Street banking trends, including its improving performance in trading and its strong rate sensitivity. While I do think a weaker macro background for 2023 remains a threat, I believe B of A is capable of mid-single-digit long-term core earnings growth and that such growth (as well as near-term earnings and ROTCE) support a fair value in the low-to-mid-$40’s.

 

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Bank Of America Still Has The Credentials To Outperform

Strong Earnings Growth Should Bring Bank Of America Back Into Favor

This year has not been a good one for the stocks of money center banks, as investor nervousness over higher capital requirements, weaker capital markets revenue, and a slowing macro environment have pushed valuations back to levels well below historical averages. Bank of America (NYSE:BAC) has been no exception, as the shares have lost about 20% of their value since my last update, underperforming other large banks over that time.

Money center banks clearly aren’t in favor right now, but I believe strong earnings growth should drive improved sentiment later this year, particularly as the banks build capital and get closer to a point where significant returns of capital to shareholders can resume. With Bank of America still offering above-average rate leverage, loan growth potential, and earnings growth leverage, I think the shares still have appeal at this lower level.

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Strong Earnings Growth Should Bring Bank Of America Back Into Favor

Bank Of America Looks Quite Appealing Ahead Of Rate Hikes

 

Writing about Bank of America (BAC) back in August, my feelings on this giant bank were mixed – while I liked the long-term growth outlook and the bank’s leverage to higher rates, I didn’t see the near-term setup or valuation as compelling enough to suggest buying. Since then, the shares have modestly lagged the large bank peer group (up around 6% versus 9%), even though there have been clear signs of acceleration in the business.

Obviously Russia’s invasion of Ukraine threw more uncertainty into the global economic outlook, but the “on the ground” operating conditions for Bank of America in the U.S. continue to improve, and not only is Bank of America the most asset-sensitive of the large banks, it has multiple drivers of growth including an expansive commercial lending operation and strong retail banking and wealth management operations.

With a modestly upgraded growth outlook, I think Bank of America looks quite interesting here, with near-term undervaluation in the double-digits and longer-term total return potential likewise in the low double-digits.

 

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Bank Of America Looks Quite Appealing Ahead Of Rate Hikes

Bank Of America Fueled Up And Ready To Go When Rates Cooperate

 

On balance this was a good reporting cycle for the banks and the sector has modestly outperformed the S&P 500 since earnings began. For Bank of America (BAC) it wasn't an especially strong quarter, but then there really weren't any issues that cause me any lingering concerns about the business plan or managements ability to execute. More than anything, I think of this quarter and Bank of America like someone sitting in their car glancing at their watch and wondering when they'll be able to finally get going.

I didn't really see Bank of America as notably undervalued when I last wrote about the stock, and instead thought it was valued in line with the larger banks. Since then the shares have moved almost in lockstep with the larger bank index (the KBW Nasdaq Bank Index (BKX)). I still don't see enough fundamental undervaluation here to make it a must-own, but I do think it's a perfectly valid option for longer-term holders - the one caveat is that Bank of America's high asset-sensitivity would be a drag if rates stay for longer, but also a way to play a more aggressive investor view on rates.

 

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Bank Of America Fueled Up And Ready To Go When Rates Cooperate

Bank Of America's Run Of Outperformance Fairly Values The Longer-Term Opportunity

 

I liked Bank of America (BAC) ("B of A") back in the summer of 2020, as I thought the market reaction to the near-term pressures on the banking sector were extreme relative to the long-term opportunities for this leading consumer and commercial bank. Since then, the shares have largely outperformed most of the bank's mega-cap peers (Citigroup (C), JPMorgan (JPM)) with a roughly 85% total return, though a few (PNC (PNC) and Wells Fargo (WFC)) have done better.

With the run in the shares, I'd say that the market fairly values the opportunity I see for Bank of America. I do expect the company to leverage its strong franchise, scale, and IT capabilities to continue gaining share in the fragmented U.S. banking market, but I don't see the outsized returns I saw before.

 

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Bank Of America's Run Of Outperformance Fairly Values The Longer-Term Opportunity

Bank Of America Still Undervalued As It Invests Through The Downturn

Bank of America's (BAC) recent share price performance (over the last three to six months) has certainly left something to be desired compared to its peer group, but that's not entirely unexpected given the bank's well-above-average rate sensitivity and management's decision to continue investing in the long-term growth of the business. I believe that the latter point will prove important over time, as BAC continues to build up its digital banking capabilities and fee-generating businesses with an aim toward consolidating even more U.S. banking business.

My sentiment on Bank of America isn't much different than it was a quarter ago - I think the shares are meaningfully undervalued and offer attractive long-term potential, but the bank is not particularly well-positioned for the current environment and relative operating performance is going to be lackluster for a while. Investors who aren't so concerned about near-term performance (or aren't interested in market timing) should take a closer look, but this is a name that will need some time (and interest rate normalization) to outperform.

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Bank Of America Still Undervalued As It Invests Through The Downturn

Bank Of America In The Rapids Now, But Still In Good Shape

In a pretty short period of time, major banks like Bank of America (BAC) have seen their operating environments shift from more or less stable (with some questions about economic growth and credit quality, sure) to whitewater rapids. Adding to that is the fact that there really isn’t a roadmap for what happens next – bank management teams have experience with recessions, credit bubbles, and so on, but epidemic-driven challenges are a new twist.

I believe the high-quality majors, including Bank of America, JPMorgan (JPM), and PNC (PNC), will get through this okay, but with so much uncertainty about when businesses (and the economy in general) will get back to normal and what the credit losses will look like in the meantime, it’s hard to have much confidence in modeling. I do believe that Bank of America is undervalued here, though, and worth consideration even though the next year (or two) will be challenging.

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Bank Of America In The Rapids Now, But Still In Good Shape

Bank Of America Flexing Its Muscles As A Consumer Banking Titan

Despite a more challenging operating environment, those banks with legitimately strong franchises and cogent growth plans (particularly those with a strong IT/digital element) continue to prosper. I liked Bank Of America (BAC) back in May, and not only have the shares outperformed the banking sector as a whole, they’ve outperformed the S&P 500 as well. Likewise, BofA stands out favorably in its mega-bank peer group, though my preferred choices, JPMorgan (JPM) and Citi (C), have done a little better over that time.

While I still love JPMorgan, Bank of America seems to have a little more appeal now on a valuation basis. This isn’t just a valuation call either; although BofA’s loan growth has come back to earth a bit, the bank continues to take share in the consumer banking market and the company’s ongoing tech investments can unlock further operating leverage down the road.

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Bank Of America Flexing Its Muscles As A Consumer Banking Titan

Huntington Bancshares Undervalued, But Not Looking Catalyst-Rich

Finding undervalued stocks is one thing, but finding catalysts and drivers that will close that valuation gap is often an overlooked part of the investment process (and a part of the whole “value trap” phenomenon). When I look at Huntington Bancshares (HBAN), I see a basically well-run bank trading more than 10% below fair value. I also see a bank that is forgoing some near-term growth to improve its full-cycle performance.

What I don’t see, though, is what will change investors’ minds about these shares in the near future. Worries about the health of shorter-cycle industrial markets are relevant to this Ohio/Michigan-centric back, as are the ongoing tariff issues with China and Mexico and the uncertain prospects for the USMCA. On top of that, while I think Huntington would/will do better in a banking downturn, the near-term outlook for pre-provision profit growth is pretty average-looking.

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Huntington Bancshares Undervalued, But Not Looking Catalyst-Rich

JPMorgan Building On Strengths Outside Of Banking

JPMorgan (JPM) is one of the largest, and in my opinion also one of the best-run, banks in the U.S., but core deposit/lending banking operations are only part of the story. JPMorgan also has a significant payments business, and management has made it clear that they view growing this high-margin, high-returns business as a core priority. To that end, the company recently announced its largest deal since the financial crisis, and I expect further investments (both organic and M&A) to grow this business.

Although I continue to believe that core banking has more or less plateaued for this cycle, JPMorgan continues to stand out for the quality of its operations. Looking ahead a bit, I believe the company’s plan to drive organic growth (new branch openings) and leverage its substantial IT investments will drive better-than-average growth and cost leverage. There are bigger bargains in the banking sector today, but in terms of quality and value, I believe JPMorgan’s double-digit discount to fair value still makes it a name worth considering.

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JPMorgan Building On Strengths Outside Of Banking

Quality, Value, And A Little Bit Of Growth - Bank Of America Seems To Offer Quite A Bit

There are some exceptions, of course, but investors who want to invest in U.S. banks today have to make some choices and trade-offs between quality, value, and growth. JPMorgan (JPM) has quality and growth, but not as much value. U.S. Bancorp (USB) has quality and maybe more growth potential than believed, but also not much value. Citi (C) and Wells Fargo (WFC) may offer more value, but quality is certainly an issue with both franchises.

And that brings me to Bank of America (BAC). Bank of America has the scale (#2 overall in deposits and assets) to keep up with the likes of JPMorgan and Wells Fargo in IT investments and drive operating scale, but it also done quite well with expenses and deposit costs without overly compromising loan growth. I don’t wish to position or suggest Bank of America as a scintillating growth story, because it’s not, but management continues to invest in growth opportunities like digital banking and opening branches in new strategic markets, and I believe Bank of America can beat the average large bank in pre-provision profit growth over the next three to five years.

All that, and a stock I think should trade closer to the mid-$30’s.

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Quality, Value, And A Little Bit Of Growth - Bank Of America Seems To Offer Quite A Bit

With More Earnings Reports In Hand, Wells Fargo Looking Even Worse

Expectations have been relatively low for Wells Fargo (WFC) ever since the asset cap was put into place, but this large bank has nevertheless managed to disappoint, with the shares underperforming banking indices by about 12% over the last six months and 10% over the last three months. With a sizable number of Wells Fargo’s peers now having reported their first quarter earnings, a look back at Wells Fargo does not look so good for this struggling bank.

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With More Earnings Reports In Hand, Wells Fargo Looking Even Worse

BB&T Basically On Track Ahead Of Its Game-Changing Merger

Despite the significant long-term potential benefits of BB&T’s (BBT) merger of equals with SunTrust (STI), the market is still generally against M&A in the banking sector, and BB&T shares have lagged regional bank indices a bit since the deal announcement (about 300bp of underperformance). I continue to believe this is a strong merger, though, and I think BB&T shares remain one of the more interesting values among banks in its weight class.

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BB&T Basically On Track Ahead Of Its Game-Changing Merger

U.S. Bancorp Doing Fine And Ready To Start Making Some Moves

As one of the best banks out there in terms of quality, U.S. Bancorp (USB) tends to be better as a “safe haven” or a long-term holding. When bank stocks were falling apart in late 2018, U.S. Bancorp held up a little better, but the shares have also lagged peers since the start of this year as banks have largely kept pace with the S&P 500.

I expect that it is going to be harder for banks to grow going forward, as I think net interest margins are peaking and credit costs are likely to head higher from here. Loan growth is healthy now, but I do still have some concerns about the overall economy. With that backdrop, I think organic growth drivers are going to be more important, and with U.S. Bancorp now free of its consent orders, it has more options to drive growth through organic expansion and branch rationalization. U.S. Bancorp isn’t particularly cheap now, but it’s definitely a name to watch for relative underperformance.

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U.S. Bancorp Doing Fine And Ready To Start Making Some Moves

Citigroup Making Slow Progress, Which Is Still Better Than What's Priced In

Being somewhat bullish on Citigroup (C), mostly in the “it’s really not that bad” sense, has felt a little lonely at times, but the shares do seem to have started reflecting a bit of the slow progress that has been underway here. The shares outperformed banking peers over the past year by more than 5% and by a similar amount over the last three months and management has reiterated its target for a return on tangible common equity of more than 13% by the end of 2020.

If we’re only talking about quality, I wouldn’t recommend Citi over JPMorgan (JPM), U.S. Bancorp (USB), PNC (PNC), or BB&T (BBT) (and that list could probably go on a while…). But factoring in the substantial apparent discount to value, and Citi looks like an interesting risk/reward proposition, particularly as the bank’s non-US banking exposure could help offset some of the cycle risk in the U.S. banking sector.

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Citigroup Making Slow Progress, Which Is Still Better Than What's Priced In

The Strong Look To Get Stronger As JPMorgan Continues To Target Growth

Already one of the best-run companies I follow, JPMorgan Chase (JPM) has shown an uncanny ability to leverage its strengths and maintain a steady pace of process improvement while looking for new growth opportunities. There wasn’t much that was all that new in JPMorgan’s Investor Day presentations (nor in the 10-K), but when you’re already executing very well on a very good plan, there’s not much reason to change.

JPMorgan's shares remain undervalued in my view, even though I believe banks are no longer in the best part of their respective cycle. With a high-quality business that still has meaningful long-term growth opportunities, I still regard this as a core holding and I think the upside potential still leaves it as a name to consider for new investment.

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The Strong Look To Get Stronger As JPMorgan Continues To Target Growth

South State Bank Still Grinding Through Some Repositioning

“Ground and pound” may be effective, even necessary, as a strategy, but it’s not a lot of fun to watch, and I believe the sluggish near-term results (and expectations) for South State Bank (SSB) continue to explain this bank’s relative underperformance to broader bank indices, as well as regional peers/rivals like BB&T (BBT), Bank of America (BAC), First Citizens (FCNCA), SunTrust (STI), and Wells Fargo (WFC). Although loan growth has perked up a bit and deposit costs remain low, real earnings acceleration is probably more of a 2H’19 event and the shares aren’t comparatively all that cheap now.

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South State Bank Still Grinding Through Some Repositioning

U.S. Bancorp Shares Still Stuck

Banks have rebounded off of their December lows, but large banks have generally rebounded less strongly, and U.S. Bancorp (USB) less so than many of its peers. Although U.S. Bancorp doesn’t have the risk of a company like Bank of America (BAC) or Comerica (CMA) where a fading rate cycle takes away a major growth lever, and it does still have a high-quality set of fee-generating businesses, the company’s core operating footprint (excluding California) isn’t well-loved, operating profit growth is likely to meander in the mid-single-digits and the cycle as a whole is not favorable to banks with growing concerns about yield inversion and recession.

If you’re patient and don’t really care about how the shares perform over the next six to 12 months, U.S. Bancorp remains one of the best-run banks in the country and the shares are undervalued enough that they should generate an attractive double-digit long-term annualized return from here. PNC (PNC), Comerica, and JPMorgan (JPM) are just as cheap, or cheaper, though, and so I’d at least advise some “comparison shopping”.

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U.S. Bancorp Shares Still Stuck

Quality Not Helping PNC Financial Much, As Growth Concerns Mount

I expressed some concerns with PNC Financial’s (PNC) position vis a vis near-term growth prospects last quarter, and those concerns really haven’t gone away. I think this is a very well-run bank and a solid candidate for a long-term position, but the lackluster results (highlighted by weak loan and revenue growth) have led to relative underperformance compared to other large banks like BB&T (BBT), Bank of America (BAC), Wells Fargo (WFC), U.S. Bancorp (USB), and J.P. Morgan (JPM).

Not much has really changed in my basic view of PNC Financial. I do see some risks to the company’s middle-market lending business and its “thin branch” digital banking expansion, but I think those risks are more than adequately reflected in the share price. Likewise, while I don’t dismiss the risk of weaker economic conditions over the next two or three years, just low single-digit adjusted earnings growth is enough to drive an appealing long-term return from here.

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Quality Not Helping PNC Financial Much, As Growth Concerns Mount

Comerica Has Thawed A Bit, But Expectations Are Still Modest

I don’t really evaluate or recommend stocks on a short-term return basis, but I won’t pretend that it hasn’t been nice to see Comerica (CMA) jump over 10% (beating underlying regional bank indices by about 5%) since my December update when I flagged expectations/sentiment as unusually low. Better still, it looks like expectations are still quite modest even after this stock and this sector have both rebounded from their December lows.

I’m still troubled by Comerica’s relatively weak loan growth, though it looks as though that may accelerate in 2019. Likewise, Comerica’s guidance for mid-single-digit net interest income growth could prove conservative as it includes no further rate hikes. I’d certainly recommend keeping an eye on loan growth, credit quality, and spread leverage here, but even just low single-digit long-term growth should be able to support a fair value more than 10% above today’s level.

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Comerica Has Thawed A Bit, But Expectations Are Still Modest