Like many other players in the financial sector, regional bank KeyCorp (KEY +3.35%) has been on a tremendous run recently. Its stock is up roughly 40% year to date and has more than doubled over the past 12 months, as Wall Street looks favorably on an institution well-positioned to take advantage of a growing economy, loan growth, and rising interest rates. But after such a strong run, let's take a look at what investors can expect from the stock for the rest of this year and long term.
Earnings projections
Based in Cleveland, KeyCorp, with $176 billion in assets, has a diverse geographic footprint ranging from New England to the Pacific region. Most of its loans are in the commercial space, although the bank is working to ramp up its new digital consumer bank, and it also has a sizable investment banking and capital markets operation.
After a tumultuous year during the pandemic, KeyCorp management is guiding for 2021 to be the bank's best year of earnings since 2018.
| KeyCorp Income Statement | 2021 Projections |
|---|---|
| Net Interest Income | $4.185 billion |
| Non-interest Income | $2.811 billion |
| Total Revenue | $6.996 billion |
| Provision for Credit Losses | ($178 million) |
| Non-interest Expense | $4.109 billion |
| Income Before Taxes | $2.709 billion |
| Net Income (19% tax rate) | $2.194 billion |
| Net Income to Common Shares (minus preferred stock dividends) | $2.088 billion |
Source: Author calculations, Q1 earnings materials, management guidance
Dividing by my estimated share count at the end of the year, I arrive at an earnings per share forecast of $2.34 for 2021. That's actually $0.03 over the high estimate currently set by analysts for this year. The numbers I am using are based on the high end of the ranges provided by management in order to weigh the potential upside for the company.
Most of what is driving the earnings improvement in these projections is the forecast for 6% growth in non-interest income and what is likely to be one of the bank's smallest credit-loss provisions in years. Management said non-interest income should benefit from growth in most of its core fee-based businesses. In particular, on the bank's recent earnings call, CFO Don Kimble said it could see another year of record investment banking activity, likely driven by a surge in mergers and acquisitions.
I am also only expecting KeyCorp to make a credit-loss provision (money set aside to cover potential loan losses) of $178 million for the year. That would be the bank's smallest annual provision in the past five years. At the end of the first quarter, the bank had enough money reserved to cover potential loan losses totaling roughly 1.60% of its loan book. But management expects to see only 0.35% to 0.45% of its loans charged off this year. (Charged-off debt is viewed as unlikely to be collected, and net charge-offs are a good indicator of what the actual losses will be.)
After accounting for expected loan growth and charge-offs, and assuming the allowance for loan losses ends the year around 1.40%, I calculated the bank will need a $178 million credit provision in 2021.
Image source: Getty Images.
A few considerations
Earnings estimates are only as good as the assumptions baked into them, so it's important to examine some of the numbers and factors driving KeyCorp's earnings.
First, I am using management's estimates and the high end of their ranges to show the potential upside. Growth of 6% in non-interest income is certainly an optimistic forecast after 2020's record results, which were driven by its investment banking business. I could see M&A being a bright spot for KeyCorp in 2021 -- but again, investment banking already had a big year.
On the other end, however, the forecast that net interest income will increase by 3% looks to be based on 2% loan growth, which is really uncertain across the industry. Bank of America CEO Brian Moynihan recently said his bank started to see modest loan growth in April and May. If things do pick up in the second half of the year, KeyCorp, along with all banks, could see net interest income come in higher than expected, although higher loan growth would also likely require greater credit-loss provisioning.
Where could the bank trade this year?
Over the past five years, KeyCorp has had an average price-to-earnings (P/E) ratio of about 14. The bank currently trades at roughly 9.8 times its projected 2021 earnings. If KeyCorp were to trade at a forward P/E ratio of 14, it would have a stock price of close to $33 per share -- but I think that would be too high, because while earnings should be elevated this year, analysts do expect them to trend downward in 2022.
Also, a 14 forward P/E ratio would have the bank trading at a huge premium to its tangible book value (equity minus intangible assets and goodwill). At Thursday's price around $22.90 per share, and with a tangible book value per share of $13.30, the bank trades at roughly 172% of tangible book value. After accounting for dividends and share repurchases, I expect KeyCorp can grow tangible book value per share to around $14.02 by the end of the year, which would give it a higher share price at the same valuation ratio.
The bank's shares traded at 200% of tangible book value in 2018, and they could hit that level again given the bullish outlook for the financial sector in general. But considering some of the economic uncertainty right now in the U.S., I think it's too early to say that KeyCorp will reach that valuation this year. Additionally, some bullishness is likely already priced into the stock, and my EPS projections were at the high end of the Wall Street analysts' range.
KEY Price to Tangible Book Value data by YCharts
Other than positive sentiment from the banking sector as a whole, one potential catalyst that I think could drive the bank's value back to that 200% tangible book value level or higher is its somewhat new digital bank, Laurel Road, which it acquired in 2019. Laurel Road began as a student loan refinancing platform, and it has originated $4.6 billion of loans for KeyCorp since the acquisition. KeyCorp sees this model as scalable, and recently launched Laurel Road for Doctors, which has expanded capabilities including targeted credit card offerings, a special dashboard for doctors, financial insights, as well as lending and deposit products. Time will tell how well this digital bank works, but I do see promise in this differentiated and targeted strategy.
Where could the bank trade long term?
Based on more normalized earnings, past P/E ratios, and price-to-tangible book values, I definitely think KeyCorp could trade at 185% of its tangible book value by the end of the year, which implies a price target of around $26 per share if tangible book value per share grows to exceed $14. If the sector gets hot or if the market starts to assign a more favorable valuation to KeyCorp based on better-than-expected earnings or an improved outlook from part of its business (such as Laurel Road), I could see traders pushing KeyCorp's valuation to 200% of its tangible book value -- roughly $28 per share. Based on the bank's current $22.90 per share price, those assumptions imply an upside of roughly 13.5% to 22% by the end of the year.
Long term, with the bank set up to benefit from rising rates and booming economic activity, KeyCorp should be in a healthy position to grow tangible book value at a decent clip, which means if it can keep its 185% or 200% valuation, it should be able to surpass $30 per share and grow from there. However, this is also heavily dependent on the bank continuing to produce strong earnings, avoiding elevated net charge-offs, and continuing to grow its balance sheet and produce steady levels of fee income.
