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Why Does This Tiger Cub Like State Street Corp?

Andreas Halvorsen Viking GlobalState Street Corporation (NYSE:STT) is a holding company consisting of two business units: custodian bank State Street Bank and Trust and investment management services company State Street Global Advisors. State Street Global Advisors has about $2 trillion under management, making it the second largest asset manager in the world after BlackRock (NYSE:BLK). In its 13F filing for the second quarter of 2012, hedge fund Viking Global disclosed that it had initiated a position of 7.5 million shares in State Street since the end of March. Viking Global is managed by Tiger Cub Andreas Halvorsen and according to the fund’s filing State Street was the fund’s largest new position for the second quarter (find more of Viking Global’s favorite stocks).

Viking Global, according to our database of filings, was the second largest hedge fund holder of State Street Corporation (NYSE:STT) at the end of June. The largest stake belonged to Trian Partners, which is managed by billionaire activist investor Nelson Peltz. Peltz had sent State Street a letter in October 2011 urging the company to consider selling or spinning off State Street Global Advisors as well as to return more cash to shareholders. Trian’s stake of close to 10 million shares has been unchanged so far this year (see more of Nelson Peltz’s stock positions). Phil Gross and Robert Atchinson’s Adage Capital Management, which was seeded by Harvard Management when the two left the endowment, moved heavily into the stock in the second quarter and owned 2.5 million shares at the end of June (research more stock picks from Adage Capital Management).

Peltz’s activism is beginning to show at least some results. In the second quarter of 2012, State Street Corporation repurchased 11 million shares of its stock, and is still authorized to repurchase over $1 billion in shares. Results for the quarter included a 3% decline in revenue and 4% decline in net income compared to the same period in 2011, but the lower share count mitigated these decreases: EPS fell from $1 per share to 98 cents per share. Over the first half of the year, earnings per share fell 5% as expenses rose but revenue remained stagnant. Fee revenue has declined but net interest revenue has increased.

Even considering its struggling business, State Street Corporation is cheap on a quantitative basis. It trades at 11 times trailing earnings, with a dividend yield of 2.3%. Sell-side analysts are optimistic about next year, anticipating a 12% increase in earnings per share in 2013 compared to 2012 (and that the second half of 2012 will do about as well as the company’s second quarter) and therefore a forward P/E of 10. We’re not sure repurchases will be quite enough to achieve that on their own, and we don’t anticipate much earnings growth at the company, but as long as continued share repurchases help offset any future declines in earnings State Street is probably fairly priced. Of course, if the company is able to grow its net income repurchases will multiply the effects of this growth.

We think that looking at a set of peers including BlackRock (NYSE:BLK), Bank of New York Mellon (NYSE:BK), Northern Trust (NASDAQ:NTRS), and JPMorgan Chase (NYSE:JPM) provides adequate comparables for both sides of State Street’s business. JPMorgan Chase, which we think is still suffering from poor investor sentiment following its London Whale losses, is the only peer trading at a lower earnings multiple (9) with the other three companies posting multiples ranging from 12 to 18. State Street is square in the middle of these four comparables on a forward basis. Northern Trust is the only one which grew its business in its most recent quarter compared to a year ago, with the three other companies reporting over 5% declines in both revenue and earnings. We like JPMorgan Chase but we can see State Street’s pricing as attractive compared to the rest of its peers; in addition, Peltz’s continued involvement could spell more upside at the company that is not priced into the stock.

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