It's next to impossible to predict a stock's movement up or down, particularly over the short term. However, there is an argument to be made that long-term investors who buy quality stocks at fair valuations can do quite well in the markets.
Source: PNC website.
In this post, we'll break down three reasons PNC Financial Services Group (PNC -1.11%) could rise over the long term. It's never a sure thing, but this analysis of the bank's fundamentals indicates that PNC may be a good bet for long-term value investors.
1. PNC Financial Services Group understands technology in banking (and how that can dramatically reduce expenses)
Typically, investors use something called the efficiency ratio to measure how well banks manage expenses. This ratio is calculated as the percentage of the bank's total non-interest expenses relative to its total income. The lower the ratio the better.
According the PNC's most recent regulatory report filed with the FDIC, the bank's efficiency ratio was 62.9%. The FDIC reports in its most recent Quarterly Banking Profile that the average efficiency ratio for banks with more than $10 billion in total assets was 59%.
That means PNC has room to improve, and it's doing just that using new technology.
At the Barclay's Global Financial Services Conference on Sept. 9, 2014, PNC CEO William Demchak explained exactly how this strategic plan looks. Using emerging mobile and Internet technology, PNC is increasingly moving to a self-service model for its customers. These businesses and individuals can access the services they need whenever and wherever using the Internet or their smartphone. This is an industry-wide trend, but PNC is implementing the technology more aggressively than its competitors.
Forty-five percent of PNC's consumer checking account customers primarily transacted either online or on a mobile phone. That's an 8% year-over-year increase as of the second quarter. For investors, that means less need for expensive branch locations, full-time employees, and overhead expenses. From the second quarter of 2013 to the end of the second quarter in 2014, the percentage of total transactions inside a branch dropped 10% to 67%.
Non interest expenses were down 8% year over year from fiscal year 2012 to fiscal year 2013. Comparing the first of half of fiscal year 2013 with the first half of 2014 shows that trend continuing, with non interest expenses declining an additional 4% year over year.
This transition makes the bank leaner and more efficient. The rapid adoption shows the bank is giving consumers exactly what they want as well. It's a true win-win proposition.
2. PNC Financial services will make a ton of money when interest rates rise
Most experts expect the Federal Reserve to end its current montary policies in the next 12 to 18 months. When that happens, interest rates are expected to rise well above their current levels.
For large banks in general, and PNC specifically, this change in policy will provide an immediate boost to revenues. Hidden away deep within the company's SEC filings, PNC's management team breaks down the bank's positioning for this change. Here's an excerpt that sums up the potential upside.
Source: PNC Financial Services Group 10-Q.
Breaking it down, this chart tells us that if interest rates rise by 1% over the next 12 months, the bank's net interest income will increase by 2%. In year two, another 1% rise in interest rates will increase the bank's net interest income by a whopping 6.8%!
In other words, when interest rates rise, PNC's income is going to explode.
3. PNC Financial Services looks cheap
According to data from Yahoo! Finance, PNC Financial Services Group currently trades at 1.1 times book value. As a general rule of thumb, a bank stock is considered cheap if it trades below 1 time book value, and expensive if it trades over 3 times book value.
After reviewing the bank's financials, I can't find any reason significant enough to justify the current valuation. The bank does not have any major credit quality issues to speak of, its capital levels are more than adequate, and the company's management team has proven over the past few years to be experienced, effective, and shareholder friendly.
It's no fluke that the company's tangible book value per common share has increased 200% since Dec. 31, 2007 -- outpacing Wells Fargo's 147% increase, BB&T's 51%, and US Bank's 144%.
The bank earned just over a billion dollars in net income in the second quarter, returned over 10% on equity, and 1.3% on average assets. Over the coming months and years, I expect PNC to continue to improve its efficiency, grow revenue, and put shareholders first.
PNC Price to Book Value data by YCharts.
At just 1.1 times book value, investors can buy a first-class bank at a bargain basement price.
Foolish takeaway
When you boil this narrative down to its fundamentals, the case for PNC is very clear. The bank is effectively cutting costs while still enhancing the customer experience. Revenue is poised to grow through normal organic business as well as a unique position in the macro economy. And, perhaps best of all, PNC is currently priced at a very, very attractive valuation.
It's impossible to predict if a stock will or will not move higher or lower. But for the three reasons presented here, PNC Financial Services Group presents a strong case for a movement higher over the next few years.
