Bank of NY Mellon – Taking Care of Business(es)

BK:NYSE Nov. 20, 2009 - $26.05

Dividend = $0.09 quarterly = 1.38% current yield


Bank of New York Mellon was created by the July 2007 merger between Mellon Financial and Bank of New York making it one of the world's largest financial services companies. BNY Mellon is a leader in providing back-office services to other financial firms. The bank's asset-management and private banking operations serve institutional and high-net-worth individuals globally.


BK took a huge ($2.54 billion) write-down of its investment portfolio in its September quarter. Management indicated at that time that 90% of the charges had been previously recognized and had already been deducted from their reported capital. Excluding the non-recurring write-offs they earned about $0.54 /share for Q3 with both assets under management and assets under custody both up nicely from Q2 levels.


On continuing operations the consensus views for 2009 and 2010 are now $2.07 and $2.40 respectively. That would put EPS at all-time highs this year and next. Here are BK’s per share (fully diluted) numbers (from cont. ops.) as reported by Value Line:



* 2009 includes Q4 estimates


Value Line sees BK’s financial strength as ‘A’ rated and Standard and Poors lists BK as ‘low risk’. At today’s quote of $26.05 the shares trade for< 12.6x this year’s and about 10.9x the 2010 estimates. Compare those multiple to the historical levels from the chart above to see how cheap these shares look right now.


S&P has a 12-month price target of $33 and sees ‘fair value’ at $32.10 /share. Morningstar agrees and calls fair value at $32 /share. Even 13x next year’s estimate would bring BK shares back up to $31.20 or 19.8% above the current price. Add in the 1.38% current yield and a > 21% total return appears likely over the next year.


Is that $31 level reasonable? BK shares have actually traded well above that price at some point in each of the past twelve years. With record earnings expected in 2010 that goal could prove to be too conservative.


Want a way to play with a built in margin of safety? Consider this buy/write combo for the next 14 months:






If BK shares rise to $30 or better (+15.2%) by Jan. 21, 2011:


· The $30 calls will be exercised.

· You will sell your shares for $30,000.

· The $30 puts will expire worthless.

· You will likely have collected $360 in dividends.

· You will end up with no shares and $16,340 in cash.

· You will have no further option obligations.


This best-case scenario return would be a net profit of $13,540/$16,100 = 84%

achieved in just 14 months on shares that only needed to go up by $15.2% or more.





What’s the risk?


If BK shares remain< $30 on Jan. 21, 2011:


· The $30 calls will expire worthless.

· The $30 puts will be exercised.

· You will be forced to buy another 1000 BK shares.

· You will need to lay out an additional $30,000 in cash.

· You will likely have collected $360 in dividends.

· You will end up with 2000 BK shares and $360 in cash.

· You will have no further option obligations.




What’s the break-even on the whole trade?


On the original 1000 shares it’s their $26.05 purchase price

less the $2.95 /share call premium = $23.10 /share (ignoring yield).


On the ‘put’ shares it’s the $30 strike price less the

$7.00 /share put premium = $23.00 /share.


Your overall break-even would be $23.05 /share (ignoring dividends).

BK shares could drop by $3 /share or (-11.5%) without causing a loss on this trade.





Disclosure: Author is long BK shares and short BK options.



___________________
Dr. Paul Price: After college at The American University [BS - 1971] and dental school at University of Pennsylvania [DMD - 1977] Paul served as a dental officer in the United States Air Force both domestically and overseas in Turkey and England. As his student loans diminished he was seduced by the market. From casual investing, starting in 1977, he devoted more and more time to equity research. In 1987 he made a full-time career switch by joining Merrill Lynch. Over the next 13 years he also worked with A.G. Edwards, Wheat First [now Wachovia Securities], and Ferris, Baker Watts. Dr. Price had enough success to retire in October 2000 but continues to help friends and family with their investments. He continues to give occasional investment seminars for civic groups and business schools.

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