Avoid This Overvalued Stock
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PNC Financial (NYSE: PNC), a top ten sized domestic bank, also gave an up tempo and optimistic presentation at the Barclays Capital 2012 Global Financial Services Conference. PNC has had a rough first half of the year. Expenses have trended up as the big bank incorporated the large acquisitions it had made in the past eighteen months. It has also taken large reserve provisions in order to cope with government agencies' agendas of demanding redemption of mortgage securities that were sold by mortgage banks mid to late last decade that since have soured. As a result, earnings in PNC's second quarter were a disappointing $546 million, or $0.98 per share. In the 2011 second quarter, earnings came to $912 million, or $1.67 per share. Management pointed to a $403 million after tax reserve charge as the driver of the lowered earnings.
PNC's presentation focused on its long-term potential in light of its recent growth in assets, customers and accounts. The bank has more than tripled in size since 2006, a year in which PNC's recorded profits of just over $1.5 billion, and a return on assets of 1.48%. PNC's more recent purchases of Bank Atlantic and Royal Bank's domestic branch network led to increase its checking account holders of over 900,000 the last two years.
In addition to integrating its recent acquisitions, which will allow for $150 million in cost savings in 2013 versus 2012, PNC has a $400 million cost cutting plan in place. The sum of $550 million in annual expense cuts will help to support earnings in 2013. So, of course, will increasing revenues stemming from the bank's enlarged customer base.
PNC believes with that $400 million addition to reserves for government mortgage reimbursement demands, when coupled with the $1.2 billion it had already paid, that the entire matter is now behind it. I am hardly as sure about that. I believe government agencies Fannie Mae (FNMA) and Freddie Mac (FMCC) have already been over reaching in assessing these demands across the banking industry. Until some bank stands up to the agencies, I do not see the practice really stopping anytime soon.
In the second quarter, PNC reported an industry leading net interest margin of 4.08%, eighteen basis points higher than the first quarter of 2012. There is no way as the purchase integrations continue that PNC will be able to maintain that margin. At best the growth in interest earning assets will allow stability in interest income in the face of the inevitable declining yields. I do not see great potential for long-term growth, and with PNC currently sporting a five year PEG of over 3, this is clearly an overvalued issue. I would want to see more stability and predictability before investing here, as well.
Kelly King, the outspoken CEO of BB&T Bank (NYSE: BBT) gave the Barclays presentation on behalf of his bank. While smaller than PNC, BB&T is still among the ten largest commercial banks in the United States with nearly $180 billion in assets, and a top five deposit market share in eight different states. BB&T is a much decentralized operation, and runs nearly as if it were a grouping of three dozen affiliated community banks. Something has worked, as BB&T has experienced annual revenue growth from 2007 through 2011 averaging 12%, versus 1.3% average annual revenue growth for other large regional banks. BB&T also enjoyed a well above average interest margin of 3.95% in the second quarter of this year.
BB&T has a proud recent history, with a fifteen year average income annual growth rate of 13.5%. The issue of course is where does the bank go from here? Its 12 month trailing total return as of June 30, 2012 was 17.9%, second among large regional banks only to U.S. Bancorp (USB). In subjective measurements such as customer satisfaction, and likelihood to recommend the bank to others, BB&T is first among large regionals. Earnings this year should approach $2.80 per share, about a 50% climb from 2011. That gives it a current year price to earnings ratio of about 11.8, and a 5 year PEG of 1.13. BB&T's earnings are also stabilized by its relatively large insurance arm. But the stock price has advanced some 18% this summer, and with a 12 month target price of just 4.8% above the stock price as I write this, I believe the stock price has gotten ahead of itself. I believe BB&T is among the best run of the large regionals. But, I would only be a buyer at a price of $30 or below.
In general, my favorite companies are those that have been beaten down, but have reasonable future prospects. No other bank has more of this than Citigroup (NYSE: C). While there are surely signs of life from this, the third largest domestic bank, it is important to be mindful that it is only trading at about 5% of its 2006 to 2007 price.
What continues to hold Citigroup back is a certain opaqueness in its balance sheet. Who knows what sorts of credit problems still may reside in its loan portfolio? The big recent news for Citigroup is a finality of the Morgan Stanley (MS), Smith Barney brokerage. The price agreed to as Morgan Stanley sought to buy out the 49% of the brokerage Citigroup owned came in substantially short of the value of the brokerage Citigroup carried on its books. As a result, Citigroup will have to take a write off of $2.9 billion, which is nearly 70% of this quarter's expected profit.
Eventually, Citigroup will dig itself out of the mess it became late last decade. That time is not at hand, and that is what makes Citigroup an intriguing choice for the risk tolerant investor. I will report on Citigroup's presentation at the Barclay's conference within a few days.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Citigroup Inc and PNC Financial Services. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
