BankUnited Offers Value with Growth

I came across BankUnited Inc. (BKU, Financial) while using the GuruFocus All-in-One Screener while looking for banks whose return on equity exceeds their price-earnings ratio. BankUnited meets that criteria.

After exploring the company further and reading the commentary from Royce Investment Partners, I liked what I saw and have since bought shares. Here are my notes.

BankUnited, with total assets of $36.3 billion as of March 31, is a bank holding company. Through its subsidiary, BankUnited, National Association, it provides a full range of banking services to individual and corporate customers through 62 banking centers in 12 Florida counties and four banking centers in New York.

The company’s lending products include small business loans, commercial real estate loans, equipment loans and leases, term loans, formula-based loans, municipal loans and leases, commercial lines of credit, letters of credit and consumer loans. Its deposit products include checking accounts, money market deposit accounts, savings accounts and certificates of deposit. The bank provides commercial and municipal equipment and franchise financing, utilizing both loan and lease structures.

An overview of BankUnited's balance sheet is illustrated below,

Royce Investment Partners' Miles Lewis commented on BankUnited in November 2021. At the time, the stock was trading around $40. It has come down since then and is arguably now a better value. He said:

"One of the companies that we like a lot right now is a company called BankUnited . They fit with what we’re looking for in terms of what we like about a bank, and that is that they’re in the state of Florida, which is a very attractive growth market. That means there’s population growth there, business formations, and that means opportunities for local, community, and regional banks to make loans and gather deposits. They have a higher cost of funding than many of their peers, and because of that they have lower margins and lower returns on assets and returns on equity. And we think that they’re dramatically improving their funding cost over time. They made a very conscientious effort to attract new clients, bringing with them their transaction accounts and their low-cost deposits, and over time as that funding cost goes down the margins are going to go up. The last reason we like BankUnited is that because we think, given their scarcity value in the most attractive market in Florida, they’re likely going to be a take-out candidate by a larger bank at some point."

More recently, Chuck Royce (Trades, Portfolio) noted while discussing his firm's high-confidence holdings:

"Another area that we are very interested in is banks. It was not historically something the firm has been strong in. But I have been convinced, with the help of Miles Lewis, that banks properly looked at can be an extraordinary opportunity. BankUnited is a great example of that. It’s located in Florida. They have scale. They are the one other banks want to beat. And they are the ones that potentially could be acquired by other regional banks. They have growth, they have excellent management, they have excellent capital allocation, they’re buying their own stock, and they’re expanding into adjacent areas. Florida is experiencing population growth. It’s very important in the banking world to actually understand the underlying growth dynamics. And many banks don’t have growth dynamics; they just participate in the financial community. We have elected to say, by and large, our banks will be in growth areas, and this is a great example."

BankUnited is trading near its book value and tangible book value. The book value per share has been growing steadily at around 8% per year and the price-earnings ratio is around 9. ROE is over 12%.

Other metrics I consider to be relevant for banks, like median return on equity and return on assets, also look good.

Valuation

I use a modified version of the Graham Number to value banks. The formula I use is: Fair Value = (Current Stock Price/ Shiller PE Ratio) * (8.5+1.5*5-Year Book Growth Rate (Per Share))

The first part of the formula (current stock price divided by Shiller PE ratio) generates the normalized earnings per share.

The second part of the formula (8.5+1.5 * 5-year book growth rate (per share) provides the growth factor. The 8.5 represents the price-earnings ratio of a bank company experiencing no growth. Each percent of growth over the last five years is given a weight of 1.5 and added to 8.5. This gives us the growth factor, which is then multiplied with the normalized earnings per share we got in the first part of the formula. (Note I use the five-year book value growth rate for banks instead of earnings growth because I find that earnings growth can be erratic and book value growth is more steady for banks and gives a better representation for growth. ) The fair value in this case works out to be $62.43, which is far above the current price of $36.23. This is a wide margin of safety.

The conventional Graham Value is also quite good at $56.28. The conventional Graham Value is a conservative valuation approach that measures a stock's fundamental value by taking into account the company's earnings per share and tangible book value per share. It is calculated as Graham Number = Square Root of 22.5 * trailing 12-month EPS * book value per share. The 22.5 is included in the formula as a rule of thumb to account for Graham's assumption that the price-earnings ratio should not be over 15 and the price to book-ratio should not be over 1.5 for an undervalued stock. The Graham Number is the upper bound of the price range that a defensive investor should pay for a stock. According to this theory, any share price below the Graham Number is considered undervalued, and thus worth investing in. Currently, there is a 35% margin of safety even below the Graham Value.

The stock also looks undervalued on a five-year median price-book and price-earnings basis, indicating value above $40.

On a price-earnings basis as compared to similar regional banks, the stock also looks undervalued.

Dividends and buybacks

While the dividend yield is mediocre at 2.6%, the bank is focused on buying back shares and has a three-year stock buyback ratio of 4.8%. The dividend and buybacks generate an excellent shareholder yield of 7.4%. I expect the buybacks to continue as the stock is undervalued.

Conclusion

So why should we consider this stock?

While the U.S. economy is expected to slow down in the next year, the South Florida economy is expected to remain strong. Florida has strong demographic tailwinds due to its warm climate and a solid business outlook. The state is a major retirement destination for wealthy people and tourists. It is experiencing strong tailwinds of the pent-up demand from Covid lockdowns that will continue as people prioritize their happiness. This should make for robust business momentum for years.

BankUnited is also undervalued on a variety of metrics as outlined above and is shareholde- friendly with solid returns through dividends and buybacks. As Royce Investment Partners pointed out, BankUnited also makes for an enticing acquisition candidate for a larger bank interested in expanding into the attractive region. If this happens, it could crystallize value quickly. A buyout price if it comes could be in the mid-$50 range.