Dale on The Finalists
Norwest and Mellon
by Dale Wettlaufer ([email protected])
ALEXANDRIA, VA (September 9, 1998) --OK, so what do I think of our two finalists, Norwest (NYSE: NOB) and Mellon Bank Corp. (NYSE: MEL)? I say buy them both, Jeff.
Well, I guess we can't do that, so we'll have to decide on one or the other. First, both of these companies are excellent and I really do have little preference for one over the other. Let's compare the companies side by side to see if I can come up with a decision on one.
First, both companies have good measures of asset activity, which we want to see in large, diversified companies. Remembering that return on assets (ROA) is a better indication of profitability than return on equity (ROE), asset activity is of very high importance, as ROA = asset turnover * net margin. Let's look at the two companies:
(revenues / average total tangible assets)
Mellon Bank..........9.25%
Norwest..........8.04%
Wells Fargo..........7.63%
NOB/WFC Combined..........7.83
Average, Large-Cap Banks..........7.12%
Compared with other banks in the money center and superregional banking group, these are all excellent. Chase Manhattan, for example, turned its assets less than 0.05 times last year. That means it takes the company 20 years to turn over its assets as compared to Mellon, which turns its assets more than twice as quickly. This matters because all else being equal, the company that is able to maintain a lower fixed asset structure relative to revenues and is able to generate more revenues per dollar of assets will be more profitable than a company that can't turn assets as quickly, net margin being equal.
For instance, Mellon's net margin (before goodwill amortization) over the last twelve months was 21.13% and Chase Manhattan's was 22.03%. However, asset turnover for Chase was 4.97%, resulting in very different return on asset results:
Chase ROA = 1.095%
Mellon ROA = 1.955%
With nearly equal net margin and an asset turnover ratio twice that of Chase, Mellon is almost twice as profitable on the level of return on assets. In both cases of Mellon and Norwest, above-average ROA results are main attractions, indicating that the companies are delivering value to customers with the right cost structure. It also means that these companies don't have to lever up their equity bases to deliver a solid return on equity. Though Mellon is currently more leveraged than the average bank (based on its measure of tangible assets to shareholders' equity), its return on tangible equity is huge, at over 40% and its ROE2 (earnings before goodwill amortization / average total equity) is 22.84%.
The reason why we like both banks is because each has a good mix of business lines. I sometimes believe that the banks that try to do everything -- the universal banks -- run the risk of becoming like a '60s style conglomerate, hoping the good business lines will pick up the slack when other business lines aren't going very well. While I like diversification, I also like to see a company doing well in each of its business lines and I don't put much stock in the conglomerate approach. From an outside observer's viewpoint, it's harder to tell what each component is doing, especially when a company restricts individual investors' access to its conference call replays. One can tell quantitatively what's going on, but that never captures the forward-looking aspect of business analysis.
While what we have at Mellon and the combined Wells Fargo (which is what the combined company will be called) are highly diversified financial services companies. Mellon is becoming more and more of a fee services sort of company, similar to a T. Rowe Price (Nasdaq: TROW) or a Merrill Lynch (NYSE: MER), and less and less of a net interest spread sort of institution, which is what a savings & loan, for instance, does.
The average large banks runs at a non-interest income to total revenues (noninterest income plus net interest income before loan loss provisions) ratio of 46%, and that includes companies that I've thrown into the group, such as Merrill Lynch and American Express (NYSE: AXP). Though that skews the average, Mellon's ratio of noninterest income to total revenues is 65.3%. This is excellent and tells much of the tale of what kind of company this is. Norwest's ratio is 42.7% and Wells Fargo's is 38.6%, combining for a 40.6% ratio. Compared with other large regionals and money center banks, Wells Fargo runs a lower ratio, which isn't worrisome, really. Stacked up against the entire banking universe, the company does fine:
BankAmerica...46.%
Chase Manhattan...53.7%
Citicorp...48.1%
NationsBank...40.8%
BankBoston...43%
First Union...40.3%
KeyCorp...30.6%
SunTrust...34.1%
US Bancorp...37.5%
What we really like about Norwest is the company's approach to the banking business in general. Though we've talked about this before, I think it bears a review as we summarize the our two choices. We'll look at that tomorrow as I wrap up my take on choosing a financial services investment.
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