Bank of New York Mellon: Underperformance, But Nice Dividend

Thesis

Despite The Bank of New York Mellon (NYSE:BK) being a well-known global brand, I believe that your money would be better suited elsewhere. The company has underperformed the sector, competitors, and the S&P for a decade. Despite a heftier starting dividend yield of 4%, it's hard to rate BK with a buy when the total return including distributions doesn't manage to keep up with most of the competition.

Earnings were reported today on Oct 17th, 2023. However, the most important metric is that over the last 3 months, there has been only 2 upward EPS estimate revision while there has been 9 downward revisions. I don't think that BK is necessarily a bad company, but their lack of returns to shareholders keep me on the fence for recommending it. We will dig into their latest earnings report later on in this analysis.

However, their cash flow has been able to support the dividend payouts as the dividend has increased consistently for over a decade. With that said, I would understand that there's a portion of you who would continue to hold simply for the dividend income. Once again though, if income is what you're after then I believe your money can be better suited elsewhere.

Overview

The Bank of New York Mellon Corporation, is a financial services company with a diversified range of business segments. Primarily, the institution specializes in providing asset servicing, wealth management, and investment management services. Within its operations, BNY Mellon plays a critical role in safeguarding and managing financial assets for institutions, corporations, and individual investors.

BK offers services such as custody, fund administration, and securities lending. In addition, it actively manages investments through its investment management arm. BNY Mellon's umbrella of financial services supports clients across the globe which contributes to their recognizable brand.

Underperformance

As we can see, BK has severely underperformed their competition as well as the S&P (SPY) in terms of total return. BK is down roughly YTD and this is more than likely as a result of the recent Moody's downgrade of U.S banks and lenders as well as being close to the realm of the Silicon Valley Bank fiasco.

However, long term underperformance can be attributed to other factors such as their lackluster revenue growth compared to the sector median. BK has a revenue YoY growth of 4.6% compared to the sector median of 7.4%. We can see in the chart how revenue over the last decade has been mostly flat. However, we did see a peak in net income prior to the pandemic crash of 2020. Although, BNY Mellon has managed its long-term debt prudently, resulting in a capital structure that currently bears manageable risk.

It can be difficult to justify holding a stock that is simply underperforming. Remember though, some investors don't necessarily target the best possible total return and instead value consistent dividend payouts.

Dividend

The starting dividend yield stands at a little over 4% according to the latest declared dividend of $0.42/share quarterly. This latest declared dividend represents a 13.5% raise over the prior.

Admittedly, BK has a history of dividend raises. The last raise was 13.5% and they have increased payouts for 12 years consecutively. This establishes a reliable pattern for quarterly income potential for shareholders. Comparing the dividend yield to the sector average, it is currently 3.47% higher than the sector norm, meeting my criteria of seeking banks that match or exceed the sector average by a few percentage points.

The 5 year growth rate of the dividend comes in at roughly 9% per year which is pretty great. Luckily, the dividend payout ratio is very modest at 30%. I wouldn't be surprised if we continued to see raises matching the 5 year average going into the future since the low payout ratio leaves a lot of room for growth.

Recent Earnings

Bank of New York Mellon posted mediocre Q3 results in my opinion. Their adjusted earnings per share came in at $1.27, which beat the consensus estimate of $1.14. However, this marked a decline from the original Q2 2023 estimate of $1.38. I would like to focus on BNY's losing part of the business: wealth management and investment management.

In the quarter, the revenue of their wealth management and investment management divisions were $827 million combined, a 4% decrease compared to the previous year. In the Investment Management sector, they saw a 4% drop in revenue, mainly due to the impact of selling Alcentra and changes in the mix of assets under management. Similarly, their Wealth Management experienced a 5% decrease in revenue. This was primarily due to lower net interest revenue and shifts in product offerings.

However, I will give them credit because their noninterest expenses amounted to $672 million, marking a significant 50% reduction compared to the previous year. According to their latest press release, this drop is largely attributed to a goodwill impairment in the Investment Management reporting unit during the third quarter of 2022.

AUM (assets under management) stood at $1.8 trillion, showing a 3% increase compared to the previous year. The Wealth Management sector contributes to this growth as their client assets reached $292 billion, reflecting a substantial 14% increase year-over-year.

The recent earnings have also revealed that total revenue across all segments of the business have grown 2% over Q3 of 2022. Simultaneously, revenue total revenue has decreased 2% from the prior quarter, 2Q of 2023. Lastly, net interest revenue experienced an 8% decrease from the prior quarter, totaling $1 billion.

When taking into account the other areas of the business, a summary of others will show very lackluster results. As reported, here is a summary of changes from 3Q2022 to the reported earnings for 3Q2023:

• Security Services: 1% revenue growth
• Market and Wealth Services: 6% growth
• As discussed, Investment & Wealth management services: 4% revenue decrease.

Security services are where the majority of BNY's revenue comes from. Almost half of BNY's total revenue comes from this channel of the business so it would be preferable to see a level of consistency or growth here. However, they pulled in $2.08B and despite this being a 1% increase over the prior year, this amount is a larger 7% decrease from the second quarter of 2023.

Valuation Comparison

Using some of the provided metrics, we can come up with an estimated fair stock price value. According to their latest earnings, revenue in the Securities Services sector showed a year-over-year increase of 1%, while the Market and Wealth Services units reported an even stronger growth of 6%. These positive results helped to counterbalance a decline in revenue within the Investment and Wealth Management business, which saw a 4% decrease. So let's use a conservative growth average of 3% per year based on these numbers.

Using the last 12 months earnings per share, we can calculate a total of $5.08. Using a DCF (discount cash flow) method, we can get a fair value estimate of $53/share. This would present a 24% upside from the current price level. We can see that this estimate aligns with Wall St's price target but I think it's highly likely that the price target will be reduced if BNY doesn't grow at more than 3 - 4% a year.

Despite a potential estimated upside of 24%, I do not believe BK is quite yet a buy because of the lackluster 3% estimated growth rate. This is on the low end of the spectrum for this sector median of 7.3% and a lot of competitors are simply doing better and have more attractive forward looking growth prospects. For comparison, Ares Management (ARES) has been growing their revenue fees at an annualized rate of 19% over the past ten years. ARES also has a 34% CAGR since 2017 in their fee related earnings due to AUM (asset under management) growth and operational scale. ARES's dividend growth rate has also been higher with a 5 year growth rate of 15%, albeit a lower starting yield.

Another comparison can be done against Ameriprise Financial (AMP). AMP's wealth management has a 19% CAGR since 2012. Similarly, their revenue growth YoY comes in higher at 9% compared against BK's 3%. We can see how both of these competitors faired in total performance against BNY Mellon. All of this is to say that there are simply better alternatives as some of BNY's competitors have a much better future ahead. Even with a potential 24% price gain in BNY Mellon, odds are that you will still be underperforming going forward in my opinion.

Internal Management

BNY Mellon has witnessed a series of changes in leadership throughout its history. Thomas Gibbons took the reins as CEO in 2020, leading the company until 2022 when he stepped down from both his role and the company's board. He was succeeded by Robin Vince in March 2022. Prior to Gibbons and Vince, Gerald Hassell played a pivotal role, serving as president from 2007 to 2012 and later as chairman and CEO from 2011. Lastly, Karen Peetz made history as the bank's first female president, serving from 2013 to 2016. These leaders may have each left their mark on BNY Mellon but unfortunately this turnover makes the company look a bit disorganized in my opinion.

Conclusion

Despite its initial allure of a 4% dividend yield, a decade of underperformance against sector benchmarks and the S&P raises concerns. Projections suggest challenging times ahead, with anticipated negative year-over-year earnings and modest revenue growth. A notable discrepancy between upward and downward EPS estimate revisions adds to the uncertainty.

BNY Mellon's complexity comes in from its consistent cash flow that supports the dividend growth spanning over a decade. However, its inability to offer returns in line with competitors leaves room for consideration. The bank's long-term underperformance is partly attributed to lackluster revenue growth, with a 4.6% YoY growth compared to the sector median of 7.4%.

Furthermore, BNY Mellon's sensitivity to fluctuating interest rates adds an extra layer of complexity to its investment landscape. While its dividend history and attractive yield may appeal to some income-focused investors, the overall underwhelming performance makes this just a hold. For those seeking sustained growth and competitive returns, exploring alternative investment options may be a more appealing course of action.