Is there any better news for income investors than when one of their holdings raises its dividend? As a shareholder that recently benefited from regional bank KeyCorp's (KEY -2.14%) 5.4% lift in its quarterly dividend to $0.195 per share, perhaps I can answer this question.
I would argue that a pay increase is as good as it gets for a shareholder because it projects that management is confident in the future of their company. But is KeyCorp a stock that dividend investors should buy now? Let's look under the hood at the stock's fundamentals and valuation.
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KeyCorp had a solid third quarter
KeyCorp will announce fourth-quarter 2021 earnings on Thursday, Jan. 20. But management for the regional bank with community banking locations in 15 states throughout the U.S. went ahead and announced a dividend bump on Jan. 13 (and payable in March), strongly hinting that Q4 was good. That follows a strong third-quarter report released back in October. That Q3 report showed its revenue and diluted earnings per share (EPS) both surpassed analysts' expectations. The bank reported $1.82 billion in revenue in the third quarter, which represents an 8% growth rate over the year-ago period. This easily beat analysts' forecasts of $1.74 billion in revenue for the quarter.
Net interest income edged 1.9% higher year over year to $1.03 billion in the third quarter. This was driven by higher earning asset balances and partially offset by a reduction in the spread between interest paid to KeyCorp on loans to customers and what KeyCorp pays to borrow money, which is called net interest margin. KeyCorp's net interest margin fell about 15 basis points over the year-ago period to 2.47%.
Noninterest income surged 17% higher year over year to $797 million in Q3. This was driven by the ongoing economic recovery that led investment banking and corporate services income higher by double-digit percentages.
Because KeyCorp's total noninterest expenses only grew at a 7.2% rate to $1.11 billion during the third quarter, this helped the company's diluted EPS to soar 58.5% year over year to $0.65. This was much higher than the average analyst prediction of $0.57 in diluted EPS for the quarter.
Based on Federal Reserve officials strongly hinting that the first of several rate hikes this year would begin in March, KeyCorp's net interest income should head significantly higher in the quarters ahead. This should act as a boon to the company's total revenue and diluted EPS moving forward. Expected rate hikes and KeyCorp's low earnings base in 2020 also help to explain why analysts are forecasting that the stock will grow its diluted EPS 14% annually over the next five years.
KeyCorp's balance sheet remains strong
KeyCorp's operating fundamentals appear to be promising. But is the bank's financial positioning healthy enough to withstand a hiccup in the economy? Looking at the metric that measures a bank's financial conditioning known as the Common Equity Tier 1 ratio, or CET1 ratio, the answer appears to be a resounding yes.
That's because the bank's CET1 ratio improved from an already great 9.5% in Q3 2020 to 9.6% in Q3 2021, which are both well above the legal requirement of 7% (4.5% plus an extra 2.5% of the bank's risk-weighted assets).
KeyCorp's dividend is sustainable
KeyCorp's 2.9% dividend yield is meaningfully higher than the regional bank industry average of 2.2%. This raises the question of whether the stock's dividend is safe.
In the first three quarters of 2021, KeyCorp generated $1.99 in diluted EPS against $0.56 in dividends per share that were paid. This is a dividend payout ratio of just 28%, which is in line with the industry average. This leaves KeyCorp with the buffer necessary to continue paying its dividend just as it has throughout the COVID-19 pandemic. That's why I believe the stock's 10 consecutive years of payout increases are the start of a long dividend growth streak.
A good value despite the stock price surge
KeyCorp's stock price is up a whopping 38% in the last six months. While this would ordinarily put a stock firmly into overvalued territory, this doesn't appear to be the case with KeyCorp. This is because, despite the run-up, KeyCorp is trading at a forward P/E ratio of 13.1. This is a slight premium to the regional bank industry average of 12.8, which is arguably deserved based on KeyCorp's encouraging operating fundamentals and secure balance sheet.
Income investors looking to add a quality regional bank with momentum to their portfolio should consider KeyCorp at the current share price of around $26.51.
