Is Everything Okay With The Street?

By Chad Henage - July 23, 2012 | Tickers: GS, NES.DL, STT | 0 Comments

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State Street Corporation (NYSE: STT) recently reported earnings. What's interesting, is if you compare State Street's earnings report to their competition, you can see that each investment manager has its strong points and weak spots. As a prime example, while State Street saw certain revenue categories decrease, Goldman Sachs (NYSE: GS) saw growth. Since each asset manager specializes in certain markets, investors should be careful that they not assume each company exposes them to the same types of risk.

The Headline Numbers:

Overall operating revenue was down 1.9%, and earnings per share came in at $0.98, which was down 2% year-over-year. The reason earnings per share was not worse is, the company repurchased $480 million worth of shares during the quarter, at an average price of $43.26. With shares currently trading below this number, investors have the opportunity to pick up shares today for cheaper than what the company paid. The question for investors is, do they want to pick up the shares given the current environment?

Assets Under Management:

When you consider that State Street's total assets under management were down 9%, initially this looks like bad news. However, the company did show a drastic improvement in their net unrealized loss in the investment portfolio. In fact, this loss was cut from $94 million to a current loss of $54 million. This shows that the company is making wise choices when it comes to their portfolio, and should bode well for future earnings growth. In addition, one of State Street's competitors, Morgan Stanley (NYSE: MS) has seen declines in its own total assets under management. Even with these declines, analysts are still calling for Morgan Stanley to grow earnings at a significant rate going forward. That being said, Morgan Stanley at this point is more of a turnaround play, versus State Street which is viewed as a more stable institution. However, no matter how good State Street's reputation is, this doesn't save the company from challenges when the equity markets don't do well.

Equity Market Effect:

The company's servicing fees were down 3.4%, and investment management fees decreased 1.6%. Notably, trading services revenue was down 18%. Interestingly in the trading revenue area Goldman Sachs saw decent growth with an 11% revenue increase in trading services. This was primarily due to the companies focus on fixed income trading. This is a good example of what I meant when I said, not all asset managers are the same. We can see that State Street is hurt more by challenges in the equity market, versus Goldman who benefits from the bond market. State Street specifically mentioned weakness in international trading as a primary contributing factor to their weaker results in multiple divisions. The good news is that State Street reported growth in two important earnings categories.

Two Big Positives:

In the most recent quarter, securities finance review revenue increased 4.4%, and net interest income increased an impressive 13.5%. The company said this increase was based on higher earning assets and lower funding costs. Again this is the opposite of what occurred at Goldman, which saw a 23% decrease in net interest income during the same period. Another strong point for State Street was their performance when it comes to their balance sheet.

The Sheet Of The Street:

Three particular items jumped out when looking at State Street's financials. The first was total deposits increased by 14.64%. This is impressive, and shows that State Street investors may be pulling funds out of traditional banks and placing them with the asset manager. Second, the company cut its long-term debt by 33%. This decrease in long-term debt will help the company in the future, due to lower interest expense. Last but not least, the company retired about 2.5% of outstanding shares over the last year. As you can see, State Street is making the best of a tough situation.

Conclusion:

All that is left is for investors to choose which asset manager they prefer. State Street benefits directly when the equity markets do better. With State Street paying a dividend of 2.3%, and with 9.37% expected earnings growth, the stock looks attractive. It doesn't hurt that investors are only paying a forward P/E ratio of 10.77. Using the company's equity to assets ratio of 9.91, State Street appears to have a stronger balance sheet than either of their two primary competitors. Morgan Stanley shows an equity to assets ratio of 7.98, and Goldman Sachs ratio is 7.62. However, State Street is at a disadvantage when it comes to earnings growth. With analysts calling for 17.40% EPS growth from Morgan Stanley, and 14.35% growth from Goldman Sachs, the company is going to have to improve its performance to keep up with its competition. These two companies higher growth rates could make the shares more attractive, and their dividends could be considered as just an extra kicker. Both companies sell for forward P/E ratios of less than 11, which means their expected double-digit earnings growth makes them relatively cheaper as well. At this point, if investors expect the equity markets to improve, State Street should most directly benefit. However, Morgan Stanley sells at the lowest price to book value of the three companies. Everything seems fine with State Street, but value investors should take a hard look at the opportunity presented by Morgan Stanley at the current time.

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