State Street Corp. (STT, Financial) reported its fourth-quarter and full-year 2016 results last week. The $30 billion asset management company delivered with a revenue loss of 1.5% to $10.2 billion in 2016 compared to 2015, yet profit gains of 8.2% to $1.97 billion. As observed, State Street recorded an income tax gain of $22 million compared to $318 million expenses in 2015 and arrived at better profit figures.
Shares of State Street lost 3.64% at market close while the broader Standard & Poor's 500 index reached record highs and had 0.66% gain.
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“Our fourth-quarter and full-year 2016 results reflect the strength of our business and our commitment to advancing key strategic priorities that support State Street’s growth. Highlights for full-year 2016 include:
- New asset servicing commitments of $1.4 trillion including $180 billion in the fourth quarter, reflecting strong growth with significant participation from Europe;
- Strong expense management and continued focus on positive fee operating leverage;
- Advancement of our strategic priority to become a digital leader in financial services through our State Street Beacon initiative, delivering tangible benefits to clients and more than doubling the expected annual pre-tax savings in 2016 to $175 million;
- Significant progress across all of our other strategic priorities – driving growth from our core franchise; continuing to invest in new products and solutions; and leveraging our strong capital position to return capital to shareholders.
“We are focused on our 2017 strategic priorities, which include: advancing our digital leadership through State Street Beacon; driving growth from core franchises; continuous investment in new products and solutions; and achieving our financial goals, including generating positive fee operating leverage and continuing to return capital to shareholders. We look forward to updating you on our progress throughout the year.” – Joseph L. Hooley, State Street’s chairman and CEO
Valuations
According to GuruFocus data, State Street had a trailing price-earnings (P/E) ratio of 15.3 times (industry median of 14), price-book (P/B) ratio of 1.5 times (industry median of 1) and price-sales (P/S) ratio of 3 times (industry median of 7). State Street also had a trailing dividend yield of 1.9% with a 29% payout ratio and 4.5% share buyback ratio.
Performance
State Street has rewarded its shareholders greatly in the past year. According to Morningstar data, State Street had one- and five-year total returns of 39.5% and 16.3%. In comparison, the broader index returned 23.3% and 14.2%.
(CNBC)
State Street
In its filing, State Street conducts its business primarily through the State Street Bank, which traces its beginnings to the founding of the Union Bank in 1792, 224 years ago. State Street Bank operates as a specialized bank, referred to as a trust or custody bank that services and manages assets on behalf of its institutional clients.
(10-K and Recent News Release, State Street)
State Street had $2.47 trillion in assets under management as of the end of 2016 compared to $2.25 trillion the year prior. In 2016, State Street had $28.77 trillion in assets under custody and administration compared to $27.51 trillion in 2015.
State Street’s clients include mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations, endowments and investment managers.
In 2016, State Street had 74.9%, or $21.5 trillion, of its assets under custody and administration in North America, 20% in Europe, Middle East and Africa and 5.2% in Asia-Pacific.
In the same year, State Street had 68.5%, or $1.69 trillion, of its assets under management in North America, 20% in Europe, Middle East and Africa and 12% in Asia-Pacific.
State Street had two lines of business: Investment Servicing and Investment Management.
(10-K, State Street)
Investment Servicing
State Street’s Investment Servicing line of business performs core custody and related value-added functions, such as providing institutional investors with clearing, settlement and payment services for its clients.
State Street’s financial services and products allow its large institutional investor clients to execute financial transactions on a daily basis in markets across the globe (2).
Investment Servicing generates revenue from servicing and trading fees, and also from security finance and processing fees.
In 2015, Investment Servicing segment sales rose 1.7% and contributed 88%, or $9.16 billion, in total State Street sales. The segment also had a pretax profit margin of 23.6% compared to 26.1% in 2014.
Servicing fees, in particular, contribute mostly to overall Investment Servicing segment sales and total State Street sales. In 2016, servicing fees contributed 49.7%, or $5.07 billion, in total State Street sales while reporting a loss of 1.6% in sales compared to 2015.
Investment Management
State Street provides its Investment Management services through State Street Global Advisors. In its filing, State Street Global Advisors provides a broad array of investment management, investment research and investment advisory services to corporations, public funds and other sophisticated investors.
Further, State Street Global Advisors offers active and passive asset management strategies across equity, fixed-income and cash asset classes. The segment also offers exchange traded funds –ETFs, such as the SPDR® ETF brand.
In 2015, Investment Management segment sales lost 5.1% in sales and contributed 12%, or $1.2 billion, in total State Street sales while having a pretax margin of 19.7% compared to 23.9% the year prior.
Management fees, in particular, contributed most in Investment Management revenue and second in revenue contribution in total State Street sales. In 2016, management fees grew 10.1% to $1.29 billion in sales.
Overall, State Street had five-year sales and profit growth and operating margin averages of 1.12%, 2.34% and 24.5% (2).
Cash, debt and book value
As of fourth quarter end, State Street had $72.2 billion in cash and cash equivalents and $13 billion in debt with a debt-equity ratio of 0.61 times compared to 0.63 times in the year prior. Goodwill and intangibles were just 3.1% of the asset manager’s $242.7 billion assets ompared to $21.14 billion the same period last year.
Cash flow
(10-Q, State Street)
According to its latest 10-Q filing that was available, State Street had positive cash flow from operations in its recent nine months fiscal 2016 compared to the year prior. The $2.28 billion inflow came mainly from the increase in profits recorded, increase in unrealized losses on foreign exchange derivatives and accrued expenses and other liabilities. In addition, State Street also had fewer cash outflow from its collateral deposits.
Capital expenditures were $477 million leaving State Street with $1.8 billion in free cash flow, compared to a loss of $5.3 billion the year prior.
(10-Q and 10-K Filings, State Street)
State Street allocated 92.6%, or $1.67 billion, of its free cash flow in dividends and share buybacks in its recent nine months of operations. Nonetheless, State Street had negative free cash flow in the recent three out of five fiscal years.
Meanwhile, State Street placed $28.2 billion in available-for-sale and held-to-maturity securities while receiving $28.75 billion in proceeds in the aforementioned investments.
(10-Q and 10-K Filings, State Street)
The asset manager also received positive cash inflow in net deposits, compared to the year prior. As observed, net deposits vary on a yearly basis but demonstrated a good amount of cash flow. State Street also reduced its debt by $414 million, net debt issuance and costs.
Conclusion
Besides State Street’s positive profit growth in fiscal 2016, the asset manager actually has experienced declining sales growth and operating margin in recent years.
In review, State Street’s servicing fee – being a constant revenue grower – generated a 1.6% loss in sales in fiscal 2016, while the company’s management fee business – grew 10.1%. The asset manager showed weakness in overall sales growth due to the servicing fee slowdown’s enormous contribution to total State Street sales, 49.7% or $5.07 billion.
State Street also delivered its lowest operating margin in the past five fiscal years with 20.8% in fiscal 2016, compared to 2012’s 28.7%. Meanwhile, State Street recognized an increase in operational costs in 2015 in relation to higher regulatory and compliance costs and increases in compensation and employee benefits due to additional staffing.
State Street’s balance sheet, meanwhile, demonstrated flat growth in the recent quarter accompanied by negative free cash flow in recent years.
(State Street at $76.2 a share with a trailing P/E ratio of 15.3 times, GuruFocus)
Earlier this month, Goldman Sachs upgraded State Street shares to buy from neutral, while Barclays reiterated its overweight rating and raised its target price to $92 a share from $77.
Historical profit growth and earnings multiple with an application of 20% margin gave a value of $54 per share (3).
In summary, State Street is a pass.
Notes
(1) 10-K: State Street’s investment servicing products and services include custody; product- and participant-level accounting; daily pricing and administration; master trust and master custody; record-keeping; cash management; foreign exchange, brokerage and other trading services; securities finance; deposit and short-term investment facilities; loans and lease financing; investment manager and alternative investment manager operations outsourcing; and performance, risk and compliance analytics.
(2) Me: Fiscal 2013 to fiscal 2015 data from Morningstar while fiscal 2016 figures were from the recent news release.
(3) Me: Five-year earnings multiple average: 14 times and five-year profit growth of 4.94%.
Disclosure: I do not have shares in any of the companies mentioned.
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