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Mellon: Good Company at a Good Price?
Q4 results and our next monthly investment

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By Jeff Fischer (TMF Jeff)

ALEXANDRIA, VA (Jan. 21, 2000) -- Every quarter, we review what we believe are the most important factors to consider in each of Mellon Financial's (NYSE: MEL) quarterly reports. This week, Mellon announced its fourth quarter 1999 results with its usual fanfare: a detailed, 18 page report.

Let's break it down and focus on what matters most to us.

Revenue

With Mellon Financial, we're most interested in the results regarding noninterest revenue, which is also called fee revenue. This number accounts for revenue dollars coming from the high-returning trust, investment management, administration and custody businesses at Mellon. These results are doubly important because these business lines are Mellon's primary focus.

Mellon earns considerably more noninterest revenue as a percentage of total sales compared to other "banks," reminding us that Mellon is a financial services and financial management organization first and foremost, not a bank. We like this. High noninterest revenue numbers helps Mellon raise its return on tangible assets (ROA) to a higher level than your average bank.

Excluding the effect of acquisitions and divestitures, fourth quarter fee revenue increased 13% (to $759 million) compared with the same quarter of 1998, and 12% (to $3.1 billion) for the entire year. This is the type of double-digit growth that we want to see. Much of this gain was thanks to a 15% increase in trust and investment fee revenue.

The less vital net interest revenue figure at Mellon was $353 million in quarter four, flat with $352 million in the previous quarter and down $29 million from fourth quarter of 1998. The decline is primarily due to the sale of Mellon's credit card business. Excluding that impact of that sale, Mellon's net interest revenue was flat with last year. Since it isn't seen as the growth driver of the business, this shouldn't be too concerning.

For the quarter, revenue totaled $1.4 billion, and for the year revenue totaled $5.98 billion and net income was $968 million, or $1.90 per share before an accounting charge.

Expenses

Excluding the effect of acquisitions, divestitures, and nonrecurring expenses, operating expenses at Mellon Financial rose only 1% compared to the same quarter one year ago. This efficiency continues to be excellent. However, operating expenses did rise 7% from the previous quarter of 1999, due in part to higher incentive costs in the fourth quarter. For the full year (before unusual charges), Mellon's operating expense rose only 3%, while its diluted operating earnings per share rose 12%. Very nice.

Profits and Profitability

Mellon Financial's cash operating return on annualized equity (ROE) was 45.6% in the fourth quarter -- record strong and well above the 40% level we desire. For the year, cash operating ROE was 42.6%.

Even more importantly, fourth quarter cash operating return on tangible assets (ROA) was 2.38%, up from 2.25% last quarter and 2.07% in the fourth quarter of the prior year. For all of 1999, Mellon's cash operating ROA was 2.25% compared to 2.12% last year. As always, we'll keep a close eye on this number to make sure it never declines steadily and hopefully it'll continue to rise.

(Another reminder: return on assets equals asset turnover multiplied by net margin. Asset turnover is represented by total revenues divided by total tangible assets. Please see the Fool's How to Value Stocks for much more.)

Business Risks

There are two more numbers that we typically watch: Mellon's credit quality expense was $6 million this quarter, compared to $15 million in the same quarter last year. The favorable lower expense resulted from a lower provision for credit losses following the sale of Mellon's credit card business, as well as higher net revenue from acquired property. In all, it's good. For the year, this expense was only $31 million compared to $54 million in 1998.

Finally, nonperforming assets at Mellon totaled $159 million on December 31, 1999, compared with $169 million the previous quarter, and $142 million two quarters before. The ratio of nonperforming assets to total loans and net acquired property at Mellon was 0.53% this quarter, down from 0.58% on September 30, 1999. The last quarter's 0.53% number compares to 0.44% last year, so we'll keep watching to hopefully see this slowly decline. Still, 0.53% is pretty good. The 0.44% results of 1998 were a record low for Mellon. It'd be nice to see the record hit again.

Mellon Harvested

In 1999, amidst a company restructuring and refocusing, Mellon grew tangible operating earnings per share 12%. If Mellon Financial can manage its business well enough to consistently crank out comparable results year after year, on average, then our money is likely in a market-beating, quality investment.

Mellon stock (at $31) trades at 15.2 times consensus year 2000 earnings per share estimates and currently yields 2.50%. We'll send next month's $100 investment to Mellon on Monday, January 24.

Have a Foolish weekend!

--Jeff Fischer, TMF Jeff on the message boards.

Related Links:

  • Mellon's Q4 Earnings Report
  • Fool on Mellon's 1998 Restructuring Initiatives
  • Fool explains Mellon's Business
  • Drip Port Buy Collection on Mellon
  • Drip Companies message board
  • Mellon's message board
  • Drip Portfolio

    1/21/00 Closing Numbers
    Ticker Company Dly Pr Chg Price
    CPBCAMPBELL SOUP7/8$33.06
    INTCINTEL CORP5/16$97.94
    JNJJOHNSON & JOHNSON-2 1/16$89.88
    MELMELLON FINANCIAL CORP15/16$31.81

      Day Week Month Year
    To Date
    Since
    7/28/97
    Annualized
    Drip 1.41% -5.47% 4.73% 4.73% 36.06% 13.19%
    S&P 500 -.29% -1.62% -1.90% -1.90% 53.53% 18.82%
    S&P 500(DA) -.29% -1.62% -1.90% -1.90% 56.16% 19.64%
    S&P 500(DCA) n/a n/a n/a n/a 28.36% 10.57%
    NASDAQ 1.10% 4.21% 4.08% 4.08% 169.84% 49.08%

    Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
    9/8/9722.9799INTC45.635$97.94114.61%
    11/14/9711.811JNJ80.721$89.8811.34%
    11/5/9828.3741MEL34.416$31.81-7.56%
    4/13/988.174CPB54.586$33.06-39.43%

    Trade Date # Shares Ticker Cost Value LT $ Val Ch
    9/8/9722.9799INTC$1,048.68$2,250.59$1,201.91
    11/14/9711.811JNJ$953.39$1,061.51$108.12
    11/5/9828.3741MEL$976.51$902.65($73.86)
    4/13/988.174CPB$446.18$270.25($175.93)
      Cash: $24.38  
      Total: $4,509.39  


    Key
    • S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

    Note
    Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging and our relatively significant starting costs, we do not expect to seriously challenge the S&P 500 for the first three to five years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. Final note: our investment in Campbell Soup is frozen due to fees instituted in its investment plan. Click here for a history of all Drip Port transactions.