Banks are an intriguing area of the market right now. The meltdown the industry suffered beginning in the first quarter and spilling over into April and May left a lot of bank stocks at dirt-cheap valuations. But cheap is not always good, especially if the company faces additional headwinds.
One of those cheap, beaten-down bank stocks is KeyCorp (KEY 0.88%), the holding company for KeyBank. Let's see if this is a stock that's worth an investment.
KeyCorp is trading below book value
KeyCorp was hit harder than the average bank this year, with its stock price down about 39% year to date to about $10.65 per share, as of Aug. 15. If you compare it to its peers, this bank with about $195 billion in assets (ranked 21st in the U.S.) has underperformed. The KBW Nasdaq Bank Index, which tracks the 24 largest banks in the country, is down just 16% in 2023.
So the valuation has come way down, as KeyCorp's price-to-earnings ratio is 7.6, and it is trading below book value with a price-to-book ratio of 0.93. The latter is a major signal that the stock is undervalued. But is it undervalued to the point where it is a good buy?
NYSE: KEY
Key Data Points
There were a few red flags in the second-quarter earnings report, starting with net income down 50% year over year to $251 million. It was also down from $276 million in the first quarter. While loans were up 11% to $121 billion in the quarter, the bank had $1 billion in interest expenses in the quarter, up from $750 million in Q1 and just $96 million a year ago this quarter.
This drained the amount of net-interest income to $811 million, down from $960 million in the first quarter and $1.1 billion in the second quarter of 2022. That drove down revenue to $1.6 billion, an 11% decline year over year and a 7% decline from the first quarter. Net interest margin fell to 2.12%, down 49 basis points from a year ago and down 25 basis points from Q1.
It also didn't help that noninterest income was down 12% year over year, while noninterest expenses were essentially flat. Through the first half of the year, the efficiency ratio stood at 67.5%, compared to 60.9% in the first half of 2022.
Overall, KeyCorp missed earnings and revenue estimates for the quarter and did not fare as well as some of its key competitors, like M&T Bank.
A good dividend
The case for buying KeyCorp in a crowded field of undervalued bank stocks stems mainly from its dividend. It has an extremely high yield right now at 7.4%, but that has surged after a quarter when net income dropped by 50%. It has resulted in a payout ratio that is fairly high at 54%.
While KeyCorp's liquidity is solid, with a common equity Tier 1 ratio of 9.2% -- up slightly in the quarter – it is a little lower than some of its better-performing peers.
KeyCorp has raised its dividend for 12 years straight, and I think it will find a way to maintain it. But with regulatory and economic uncertainty ahead for banks, headwinds remain, and I think there are other banks better suited to handle potential volatility.
That said, the high yield and solid dividend track record is indeed enticing. If you did invest in this stock, you're getting a good yield at a low valuation. Just keep an eye on that payout ratio.
The past couple of years, KeyCorp has bumped up the dividend in the fourth quarter. The next quarter's earnings report should provide more visibility into its longer-term prospects.
