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ovenerio
ovenerio
Articles (1681) 

A Fairly Profitable Midwestern Bank

In this article, let's take a look at Fifth Third Bancorp (NASDAQ:FITB), a $150.37 billion market cap company, which is a diversified financial services company, based in Cincinnati, which operates 1,340 branches in 12 states, with a focus on Ohio, Michigan and Illinois.

Return over time

Fifth Third Bancorp operates with four business segments: Commercial Banking (over 35% of total revenues); Branch Banking (35% of revenues); Consumer Lending (14% of revenues); and Investment Advisers (about 8% of revenues).

The bank was a fairly profitable Midwestern bank, but then provisions for loan losses started to increase, real estate prices played unfavorably and the bank's primary markets (Ohio, Michigan and Florida) started to experience the losses. Since 2007, the mean return on equity was about 18% but then fell.

1412855877040.png

It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.

Pricing power

It doesn´t have lots of competitive advantages. In Michigan and Ohio, it enjoys a deposit market share of around 30%, giving pricing power that helped achieve a good track record of results. The average efficiency ratio is around 55% in the last ten years, somewhat lower than the average of its peers.

Credit quality

The credit quality is better now due to the actions the bank has taken and credit trends are improving. Now, the company´s allowances covers more than 150% of the bad-loan balance.

CCAR program

Some months ago, the Federal Reserve did not object the capital plan, earlier submitted under the 2014 Comprehensive Capital Analysis and Review (CCAR) program. This way, it can increase its quarterly common stock dividend to $0.13, from $0.12. it is expected common stock dividends for about $1.8 billion this year, and share buybacks of $650 million.

Revenues, margins and profitability

Looking at profitability, revenue declined by 9.22% and led earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($0.49 vs $0.65). During the past fiscal year, the company increased its bottom line. It earned $2.01 versus $1.66 in the previous year. For the next year, Wall Street expects contraction of about 15% in earnings ($1.71 versus $2.01).

The gross profit margin is considered very high at 88.69%, and the net profit margin of 26.77% is above the industry median.

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 (%)

FITB

Fifth Third Bancorp

10.72

HBAN

Huntington Bancshares Inc

10.74

BBT

BB&T Corp

8.23

STI

SunTrust Banks Inc

6.60

FRC

First Republic Bank

11.04

RF

Regions Financial Corp

7.14

 

Industry Median

8.43

The company has a current ROE of 10.72% which is higher than the industry median and BB&T (BBT), Sun Trust Banks (STI) and Regions Financial (RT). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. First Republic (NYSE:FRC) is the one that is more closely to those levels.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 11.2x, trading at a discount compared to an average of 15.0x for the industry. To use another metric, its price-to-book ratio of 1.19x indicates a premium versus the industry average of 1.16x while the price-to-sales ratio of 2.71x is below the industry average of 3.1x.

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 $23,305, which represents a 18.4% compound annual growth rate (CAGR).

1412818421473.png

Final comment

As outlined in the article, a significant improvement in loan credit quality should benefit the bank in the upcoming years, reaching profitability in a scenario that should need some protection against interest rate movements.

The PE relative valuation and the return on equity that exceeds the industry average and make me feel bullish on this stock.

Hedge fund gurus like Paul Tudor Jones (Trades, Portfolio), Charles Brandes (Trades, Portfolio), Robert Olstein (Trades, Portfolio), Richard Pzena (Trades, Portfolio) and James Barrow (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014, as well as Caxton Associates (Trades, Portfolio).

Disclosure: Omar Venerio holds no position in any stocks mentioned

About the author:

ovenerio
Omar Venerio is a capital markets, derivatives, corporate finance and financial management professor and Area Head of Finance. He is passionate about the stock market and providing independent fundamental research and hedge fund and insider trading-focused investigation.

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