I was surprised when I read that BB&T Corporation (NYSE:BBT) didn’t pass the Fed’s recent round of stress tests. I’ve pounded the table for BB&T multiple times, and recently described it as “Still The Best Bank In Town.” However, in typical fashion, investors assumed the worse and sold shares. Granted, the drop in price wasn’t that severe, but the stock is still down nearly 3% compared to prior stress tests, while most of its competition showed increases. Should investors be worried?
Don’t Miss The Forest For The Trees
Investors should not be worried at all. In fact, many of the headlines grouped BB&T Corporation (NYSE:BBT) and Ally Financial together, as though both companies failed for the same reasons. Nothing could be further from the truth. Ally Financial was “rejected because the bank did not meet minimum capital ratios required to pass the stress test.” This is a completely different issue than what happened with BB&T, where “Fed officials objected to portions of the company’s capital planning process.”
In Ally’s situation, the company was deemed to need more capital to handle a downturn in the economy. In BB&T’s situation, the Fed said the bank was well capitalized, but they were not comfortable with the way BB&T was planning on spending money in the future. Under the guidelines of Dodd-Frank, an earlier round of tests found “BB&T to be the most well capitalized traditional bank in the U.S.”
The bottom line is that this is a short-term event. BB&T said they “plan to submit a revised plan that the company says will meet the Fed’s objections.”
Longer-Term Dividend Growth Will Follow Earnings Growth
In the grand scheme of things, earnings growth is what investors should be focused on. After all, in the long-run, the bank with the best earnings growth should do just fine. Just to make sure my investing thesis made sense, I wanted to compare BB&T to several of its peers.
If there is one place where BB&T Corporation (NYSE:BBT) can improve, it is in their net margin. Using the peer group of Bank of America Corp. (NYSE:BAC), J.P. Morgan & Chase, and M&T Bank Corporation (NYSE:MTB), I found only Bank of America had a lower net margin. In fact, Bank of America’s margin was just 1.65% in the current quarter, but was as high as 7.9% in the last year. By comparison, BB&T’s 18.43% net margin looks very good. However, J.P. Morgan & Chase managed a net margin of 26.25%, and M&T came in at 24.71%. BB&T investors should take note that anything these two can do, BB&T can likely match. In theory, an expanding net margin would mean better earnings in the future.
However, few of BB&T’s competitors can match is the company’s organic loan and deposit growth. Traditional banking is all about attracting depositors and making loans. In the last four quarters, BB&T’s loan portfolio grew 5.79%, and total deposits increased 7.18%. Only M&T did slightly better with loans up 6.62% and deposits up 7.71% in the last four quarters. By comparison, J.P. Morgan & Chase and Bank of America Corp. (NYSE:BAC) just don’t measure up. Neither company saw loan growth of better than 3%, and deposits grew by around 6% at each company.
When it comes to dividend payments, BB&T Corporation (NYSE:BBT)’s CEO Kelly King said he was pleased to have one of the highest yields and highest payout ratios. This is sort of backward thinking, as the company’s relatively high yield is a function of the stock not rising as much as some of its peers. Where the company’s payout ratio is concerned, the way I look at it, BB&T has plenty of room to raise the dividend further.
When calculating a free cash flow payout ratio, I only use net income plus depreciation, and then subtract capital expenditures. This eliminates some of the other adjustments to free cash flow that are not actual cash items. This also gives investors a good apples-to-apples comparison across multiple companies. Using this calculation and then taking the average payout ratio over the last four quarters shows BB&T is doing better than most.
In the last four quarters, only J.P. Morgan & Chase paid out a lower percentage of their adjusted free cash flow at 19.65%. BB&T paid about 25.35% of their adjusted free cash flow. Bank of America Corp. (NYSE:BAC)’s common stock dividend and preferred dividends actually used up 26.4% of that company’s free cash flow, and M&T paid almost 36% of their free cash flow. As you can see, BB&T could theoretically double their dividend and still pay just about 50% of their adjusted free cash flow.
A Great Value To Boot
BB&T Corporation (NYSE:BBT)’s stock value looks compelling, even with the company’s current dividend. With a yield of 2.98%, this beats all of their peers. Analysts expect 11.68% EPS growth in the next few years, which is second only to Bank of America Corp. (NYSE:BAC) at 18.7%.
What makes BB&T an even better value is that the stock sells for just 10.55 times projected earnings. Relatively speaking, only J.P. Morgan & Chase sells for a lower P/E ratio of 9.06. This short-term event gives investors a chance to buy BB&T at a slight discount to the price before the stress test. Long-term investors should jump at this chance to buy the “Best Bank In Town.”
The article Don’t Stress, This Is A Short-Term Issue originally appeared on Fool.com and is written by Chad Henage.
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