Alexandria, VA (July 1, 1998) --Yesterday, we looked at SunTrust's (NYSE: STI) financials as presented under GAAP (Generally Accepted Accounting Principles) conventions. I also mentioned the effect that SunTrust's slug of 48 million Coca-Cola Co. (NYSE: KO) shares have on its balance sheet. The company's financial results are a bit distorted by the presence of those Coke shares because SunTrust isn't exactly lending out $60 billion against their $4+ billion stake (as of today) in Coca-Cola. The stock is largely sacrosanct, comparing the company's equity base with the Coke stock in shareholders' equity and out of shareholders' equity.
I got a little antsy thinking about this yesterday and jumped the gun on talking about it. That being the case, the effect of Coke's stock on SunTrust's financials was the subject of yesterday's Fool on the Hill, part of the Evening News. This was what I had to say about it (for a spreadsheet with the adjustments I made, click here).
In all the hoopla over the consolidation of regional banks in the last 18 months, one major player has been left out of the running. But that has been by choice, apparently. SunTrust Banks (NYSE: STI), the largest bank by far in Georgia and one of Florida's largest banks, has remained independent from the likes of NationsBank (NYSE: NB), First Union (NYSE: FTU), Barnett Banks, and Wachovia Corp. (NYSE: WB). Nevertheless, its performance shows that it doesn't need to get together with a larger partner.
Over the last 12 1/2 years, the company has handily outperformed the S&P 500 by nearly four percentage points per year and has performed roughly in-line with the S&P Regional Bank stock index over the last two years. The interesting thing about SunTrust's financials is the value of the 48.27 million shares of Coca-Cola Co. (NYSE: KO) on its balance sheet. And perhaps that's also why acquirers haven't stepped up to the plate on SunTrust. The presence of Coke stock has been an interesting talisman. Some fund managers dumping General Re Corp. (NYSE: GRN) because of the Berkshire Hathaway (NYSE: BRK.A and BRK.B) merger have most likely done so by reasoning (incorrectly) that Berkshire is a closed-end mutual fund. In the case of SunTrust Bank, Coca-Cola stock (minus a deferred tax liability associated with the stock) makes up just under 41% of SunTrust's shareholders' equity. It doesn't seem far-fetched that other bank boards and CEOs would stay away, even though by the same logic, most other insurance companies or banks could be seen as large closed-end bond funds.
That aside, the way to look at SunTrust outside of the Coke holding is to simply take that stock off SunTrust's balance sheet. To do that, you have to make an adjustment to both sides of the balance sheet. Back out the value of the shares straight from assets, then back out the tax liability (the tax rate times the unrealized appreciation in the shares), and then take out the residual of the asset minus that tax liability from owners' equity. The residual value is found in the "Accumulated other comprehensive income" line of owners equity. SunTrust also puts the value of the Coke shares in its footnotes.
To figure out the value of the company, you would have to make the same adjustments to the market capitalization. As in figuring out enterprise value (market capitalization plus debt minus cash and marketable securities), you would have to back out the net value of the Coke stock from the economic price one would have to pay to acquire SunTrust. Once you've made these adjustments to SunTrust, you're ready to go to work on looking at how productive the bank is. (By the way, this treats the Coke stock as sacrosanct. In other words, I don't think SunTrust's board is making loans against the value of the Coke stock to wildcat oil drillers and developers building skyscrapers on spec.)
Having made these adjustments, SunTrust looks a heck of a lot more productive than the raw financials would indicate. Without these adjustments, it appears as though the company earns only a 13.2% return on equity, which would be a pretty paltry return for a major regional bank. Further, without backing the value of Coke out of the enterprise value, the company would be selling at nearly 25 times amortization-adjusted earnings (goodwill amortization taken out of expenses). With a return on assets of 1.2%, you would think there's some sort of SunTrust manic short-squeeze on. It would be a pricey bank at these numbers.
Working around the tax-adjusted value of Coke, though, one sees a company generating a return on equity of 21% and a return on assets (before goodwill amortization) of 1.28% over the last twelve months. Further, the company would be priced at 22 times amortization-adjusted earnings. On the basis of ROE, the company is 12.3% more productive than a composite of money center and superregional banks. That would also explain its current 17.9% premium (on trailing earnings) over the P/E for the rest of the large banking group.
Another way to look at a bank holding company's current valuation is to compare its return on assets with its price-to-tangible assets multiple. ROA may be a better number to look at because that's a better indicator of a bank's performance than ROE (please see terms and definitions linked in the top right of this page, if need be). A low ROA company can pump up its ROE with lots of leverage. ROA, on the other hand, is the same thing as ROE -- that's to say that net margin and assets turns are in there -- but without the leverage (assets to equity ratio). The correlation between price-to-tangible assets and ROA is much better at 0.69 than is the correlation between price-to-tangible book and ROE at 0.54. In other words, ROA decides 69% of the price of a banking company's value while ROE decides 54% of its value. On this basis, SunTrust is pretty fairly valued at an adjusted price-to-tangible assets ratio of 0.2685.
Aside from the technical stuff, which might be enlightening to some and boring to others, SunTrust's franchise is growing rapidly. Without making any sizable acquisitions, the company's earning assets have grown at a compound rate of 10.5% per year over the last two years, which means the company is outperforming average economic growth in the country. Being in the right region is the first part of this -- Atlanta is still growing quickly, which is a big help. Its trust and investment business is the largest part of noninterest income, which is a good thing, as this is a business that doesn't need as much capital as other banking lines. It's really the company's noninterest income lines that are performing, which is what you want to see in banking. Total noninterest income has grown at 14.5% per year over the last two years while net interest income after loan losses has only grown at a compound annual rate of around 6.3%.
Over this period, the company has been a comparatively cost-conscious bank, as its efficiency ratio (which is analogous to operating expenses divided by revenues) has stayed right around 60. With net buybacks of $431 million over the last twelve months and dividends of just under $200 million, the company's "owner's yield" is a fine 4.2% of its adjusted enterprise value. With continued asset growth outpacing economic growth, further gains in its noninterest income lines of business, and the Coke stock having a meaningful impact on the company's equity base, SunTrust should be a good performer among the regional bank sector for the foreseeable future.