Is State Street Stock Fairly Priced?
[Updated 08/05/2021] State Street Update
State Street stock (NYSE: STT) has doubled since the March lows of last year, and at its current price of $87 per share, it is 8% below its fair value of $95 – Trefis’ estimate for State Street’s valuation. Further, the U.S. bank stocks have seen strong growth in the year – the benchmark Dow Jones U.S. Banks Index is up 24% YTD. However, STT stock is slightly lagging the index (up 19% YTD).
State Street reported $11.7 billion in revenues for the full year 2020, which was marginally below the 2019 figure. While the bank reported some growth in the fee revenues driven by asset growth, it was more than offset by a 14% y-o-y decline in the net interest income. Further, the same trend continued in the first and second quarters of 2021, also. The custody banking giant outperformed the consensus estimates for revenues and earnings in the second quarter. It reported total revenues of $3 billion, which is 3% above the year-ago figure. This could be attributed to a 6% y-o-y growth in the fee income, mainly driven by higher servicing fees and management fees. The servicing fees benefited from growth in Assets under Custody & Administration (AuC/A) to $42.6 trillion – the figure was 6% higher sequentially and 10% more than the December end. Similarly, the management fees grew due to higher Assets under Management (AuM) – AuM grew 9% sequentially to $3.9 trillion. On the flip side, the top-line was partially offset by a 16% y-o-y drop in the net interest income, which suffered due to the lower interest rate environment. Additionally, the bank’s adjusted net income of $728 million increased 10% on a year-on-year basis, primarily due to a decrease in operating expenses as a % of revenues from 70.9% to 69.6%, and loan loss reserve release of $15 million in the quarter.
Moving forward, we don’t expect the interest rates to return to the pre-Covid-19 levels anytime soon, hurting the net interest income. However, growth in interest-earning assets will likely offset its negative impact to some extent. Further, an increase in assets will likely drive the fee income in the year. Overall, the above factors will likely enable State Street’s revenues to touch $11.9 billion in FY2021. Additionally, the bank’s profitability figures are likely to see some improvement in the current year, enabling the net income to touch $2.4 billion. It will likely result in an EPS of $7.18, which coupled with a P/E multiple of just above 13x, will lead to the valuation of $95.
[Updated 05/24/2021] State Street Stock Is Slightly Undervalued
State Street stock (NYSE: STT), a custody banking giant, has gained roughly 19% – increasing from about $73 at the beginning of 2021 to around $86 currently, outperforming the S&P500, which grew 11% over the same period. The U.S bank stocks have made strong gains since the start of 2021 and the rise in State Street stock confirms the same trend.
There were two main factors behind this: First, the approval of the $1.9 trillion stimulus package. Second, accelerated Covid-19 vaccination drive in the U.S. – 49% of the U.S population has received at least one dose. The above reasons support the forecasts of a strong economic recovery, uplifting investor sentiment.
But is this all there is to the story?
Not quite, despite the recent gains, Trefis estimates State Street’s valuation to be around $92 per share – 6% above the current market price – based on a key opportunity and one risk factor.
The opportunity we see is an improved trajectory for State Street’s revenues over the subsequent quarters. State Street reported a slight decline in the full year 2020 revenues to $11.7 billion, mainly driven by a 14% y-o-y decrease in the net interest income (NII) due to a lower interest rate environment, offset by a 4% growth in total fees revenue. The growth in total fees revenue was driven by a 23% y-o-y jump in trading services, a 6% increase in management fees, and a 2% growth in servicing fees led by higher Assets under Custody & Administration (AuC/A) and Assets under Management (AuM). Notably, the bank’s AuC/A grew 13% y-o-y to $38.8 trillion and AuM increased by 11% to $3.5 trillion by the end of the year.
The same trend continued in the first-quarter FY2021 as well, with the bank posting better than expected results. State Street’s reported revenues of $2.95 billion in the quarter – 4% lower than the year-ago period. While there was a 4% y-o-y growth in the fee income, it was more than offset by a 30% drop in the net interest income. The NII suffered due to lower global interest rates, partially offset by higher deposits and growth in the investment portfolio. Further, STT has seen continuous growth in AuC/A and AuM over the recent quarters, which touched $40.3 trillion and $3.6 trillion respectively in Q1 – up 4% sequentially, benefiting its investment management and servicing fees. That said, the low-interest rates are unlikely to see an immediate revival to the pre-Covid-19 levels. However, interest-earning assets are expected to continue their growth momentum in FY2021, partially offsetting some of the negative impacts of lower interest rates on net interest income. Further, growth in AuC/A and AuM are likely to drive STT revenues in FY2021, enabling them to touch $11.8 billion.
The operating expenses are likely to see a slight drop in FY2021, which is likely to improve the bank’s profitability figures for the year – EPS will likely improve from $6.32 to $6.85. The EPS of $6.85, coupled with the P/E multiple of just above 13x will lead to a valuation of around $92.
Finally, how much should the market pay per dollar of State Street earnings? Well, to earn close to $6.85 per year from a bank, you’d have to deposit about $685 in a savings account today, so about 100x the desired earnings. At State Street’s current share price of roughly $86, we are talking about a P/E multiple of just below 13x. And we think a figure slightly above 13x will be appropriate.
That said, custody banking and asset management are a risky proposition right now. While growth is likely, change in current market sentiment can harm the near-term outlook. What’s behind that?
State Street’s business model is very sensitive to movement in asset prices. While the S&P500 index is on a growth trajectory (up 86%) since the March 2020 lows, any further deterioration in the economic conditions or a sudden uptick in the Covid-19 case count can reverse the momentum. This could hurt STT’s revenues due to a reversal in asset valuations driven by net market losses. Additionally, the low-interest rate environment will likely hurt the NII of the bank. To sum things up, we believe that State Street stock is slightly undervalued and offers limited upside.
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