KeyCorp's shares closed at $10.23 Tuesday, returning 22% this year, outperforming the performance of the KBW Bank Index (I:BKX), which was up 14% year-to-date through Tuesday's close at 58.28.
The shares have also outperformed the KBW bank index since Feb. 14, the day before Mutascio took over KBW's coverage of the bank, with an "underperform" rating and a price target of $9.00. Since the market close on Feb. 14, KeyCorp's stock has returned 8%, while the KBW Bank Index is up 5%.
Shares of KeyCorp of Cleveland trade for 10.7 times the consensus 2014 earnings estimate of 96 cents, among analysts polled by Thomson Reuters.
"It seems to us that the market is implying that: 1) our EPS estimates are too low, 2) investors are more willing to apply a premium P/E multiple to the shares than we are, or 3) a combination of both," Mutascio wrote. Mutascio estimates KeyCorp will earn 91 cents a share during 2014. "If you assume investors require a 15%-20% upside from today's share price in order to obtain an adequate return over the next 18 months, then it implies a target price for KEY of approximately $12 per share," he wrote.
Based on the higher 2014 consensus estimate of 96 cents, a price of $12 for KeyCorp's stock would make for a forward price-to-earnings ratio of 12.5, rising to 12.9 if 2014 EPS ranges from 91 cents to 96 cents. According to Mutascio, "that seems like an awfully high P/E multiple for a bank expected to generate a [return on average assets, or ROA] of less than 1.0% and a [return on tangible equity, or ROTE] of less than 9.0% based on the current EPS estimates." KeyCorp's first-quarter ROA was 0.99%, while its return on average tangible common equity (ROTCE) was 9.12%. Here's how the market's apparent logic for valuing KeyCorp's shares, according to Mutascio, would stack up for four other large regional banks, all of which are expected to be more profitable than KeyCorp during 2014:
- Wells Fargo's (WFC) first-quarter ROA was 1.41% and its ROTCE was 17.76%. The shares closed at $38.40 Tuesday, trading for 10.1 times the consensus 2014 EPS estimate of $3.81. That's lower than KeyCorp's forward price-to-earnings multiple, and probably reflects the political and regulatory "target on the back" for the largest U.S. banks. KBW is ahead of the consensus, with a 2014 EPS estimate of $3.93. Applying the 12.9 forward P/E multiple discussed above to KBWs 2014 EPS estimate would lead to a price target of $51 for Wells Fargo, for upside of 33%.
- U.S. Bancorp (USB) of Minneapolis achieved a first-quarter ROA was 1.65% and its ROTCE was a whopping 23.79%. The company has consistently been the best earnings performer among the 24 components of the KBW Bank Index through and after the credit crisis. The shares closed at $33.15 Tuesday, trading for 10.2 times the consensus 2014 EPS estimate of $3.24. It is remarkable to see U.S. Bancorp trading at a lower forward P/E than KeyCorp. Based on a multiple of 12.9 to KBW's 2014 EPS estimate of $3.25, USB would have a price target of $42, for potential upside of 27% from Tuesday's closing price.
- For BB&T (BBT) of Winston-Salem, N.C., the first-quarter ROA was 1.11% and the ROTCE was 8.25%. The shares closed at $31.51 Tuesday, trading for 10.2 times the consensus 2014 EPS estimate of $3.10, which is also KBW's estimate. Applying the multiple of 12.9 to the 2014 EPS estimate would leave a price target of $40, for potential upside of 27%.
- Fifth Third Bancorp (FITB) of Cincinnati has a first-quarter ROA of 1.34% and a ROTCE of 15.23%. The shares closed at $17.51 Tuesday, trading for 10.1 times the consensus 2014 EPS estimate of $1.73. Applying the multiple of 12.9 to KBW's 2014 EPS estimate of $1.77 would lead to a price target of $23, for upside potential of 31%.
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