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KeyCorp a Solid Play for Interest Rates, Efficiency: Oppenheimer

Stocks in this article: KEY WFC FITB USB BBT I:BKX

NEW YORK ( TheStreet) -- KeyCorp (KEY) is very well positioned for rising interest rates, and its conservative strategy and "above-peer capital levels" have set up an attractive long-term play for investors, according to Oppenheimer analyst Terry McEvoy.

"Sentiment on Key is improving as investors reassess the prospects from more consistent growth led by a management team that is proving to be more disciplined with excess capital," McEvoy wrote in a note to clients on Sunday.

McEvoy rates KeyCorp of Cleveland "outperform," with a 12-to-18-month price target of $12.00. The analyst estimates the bank will earn 87 cents a share this year, with EPS rising to a dollar in 2014.

KeyCorp's shares closed at $10.78 Friday, returning 29% this year, following a 12% return during 2012. The shares trade for 11.2 times the consensus 2014 EPS estimate of 96 cents, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is 89 cents.

KeyCorp's shares this year have outperformed the KBW Bank Index (I:BKX), which was up 20% through Friday, underlining a second consecutive year of stellar performance for banks stocks.

Early last month, KBW analyst Christopher Mutascio wrote that the run-up in KeyCorp's shares to $10.23 on May 7 was " unjustified," because the shares were trading at higher valuations than many other large-cap banks that posted stronger earnings. With all boats continuing to rise since then, Mutascio's observation on valuations continues to hold true.

Here's a quick look at the lower forward price-to-earnings valuations for four big banks that beat KeyCorp's first-quarter return on average assets (ROA) of 0.99:

  • Wells Fargo's (WFC) first-quarter ROA was 1.41% and its return on average tangible common equity, or ROTCE, was 17.76%. The shares closed at $40.55 Friday, trading for 10.4 times the consensus 2014 EPS estimate of $3.90.
  • U.S. Bancorp (USB) of Minneapolis achieved a first-quarter ROA was 1.65% and its ROTCE was a very strong 23.79%. The company has been the best earnings performer among the 24 components of the KBW Bank Index through and after the credit crisis. The shares closed at $35.06 Friday, trading for 10.8 times the consensus 2014 EPS estimate of $3.24.
  • 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 $32.92 Friday, trading for 10.6 times the consensus 2014 EPS estimate of $3.10.
  • Fifth Third Bancorp (FITB) of Cincinnati had a first-quarter ROA of 1.34% and ROTCE of 15.23%. The shares closed at $18.20 Friday, trading for 10.5 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%.

But McEvoy sees several advantages for KeyCorp. One of them is the ability of the company to defend its net interest margin, which is the difference between the average yield on loans and investments and the average cost for deposits and borrowings. With the Federal Reserve keeping its short-term federal funds rate in a range of zero to 0.25% since late 2008, most banks have already enjoyed the bulk of savings on the funding cost side, while assets continued to reprice lower.

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