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Thesis
State Street Corporation (NYSE: STT) is one of the world’s largest asset managers, best known for its low-cost exchange-traded fund (“ETF”) offerings. The company is also committed to providing investment services and management solutions through a full range of products and services. After a few years of lackluster financial performance, STT stock is struggling. In this analysis, I explore the company’s performance, outlook and valuation.
A tough year so far
Given the growth of passive investing and the asset management industry in general, the performance of State Street stocks was rather disappointing. Over the past five years, STT has delivered a total price return of -26%, during a period when competitors like BlackRock (BLK) have increased their stock price to over +40% and even large banks like JPMorgan Chase & Co. (JPM ) saw positive overall price returns of +20%.
Since the beginning of the year, more struggle has revealed itself for State Street. The stock has clearly underperformed the financial sector, falling -23% since the start of the year (-14.5% for XLF). Currently, the stock is trading -32% off 52-week highs, at $70.10 per share (market cap $25.8 billion) and paying a dividend yield of 3.25%.
Macro headwinds
The investment and asset management industry is cyclical as the volume of inflows, transactions and transactions correlates to economic conditions and interest rates. During economic downturns and times of uncertainty, volume declines. As a result, service charges, commissions and management fees contract. Despite the short-term difficulties, according to a PwC study, global assets under management are expected to grow at around 6.2% annually, to $145.4 billion, through 2025. Given the mature nature of the industry, growth prospects look decent. Active management is expected to represent 60% of global assets under management (“AUM”), leaving much more room for growth in passive investing, although active investing is expected to continue to lose market share to passive assets .
Growth drivers include integration of advanced technology solutions, Asia-Pacific markets, contribution-based retirement savings, etc. Mutual funds and ETFs are also expected to experience significant growth, reaching an industry penetration rate of 42.1%. Growth in assets under management in North America and Europe is expected to slow somewhat, with emerging markets offering the best prospects.
Commercial and financial performance
State Street operates through two business segments; Investment Servicing offers custodial, clearing and settlement services to institutional clients, while the Investment Management segment provides, through State Street Global Advisors, a wide range of investment management strategies and products , including ETFs, mutual funds, actively managed funds, and more.
State Street appears to have failed to capture the tailwinds in the asset management sector, as the lack of meaningful revenue growth is partly to blame for the poor performance in stocks. Over the past five years, revenue has grown at a CAGR of 2.60%, while annualized growth in net income is 3.90%.
In July 2022, State Street released its fiscal second quarter results. The company recorded a non-GAAP revenue shortfall and an EPS overrun. Still, year-over-year declines in both have investors worried. EPS is down -8% and revenue -3%. Lower equity and fixed income markets resulted in a 6% decline in commission income, which was partially offset by an increase in foreign exchange trading services income. On the other hand, the rise in interest rates led to a +25% increase in net interest income. Total expenditure remained stable year on year. Assets under management decreased by -11% year-on-year, mainly due to declines in equity and fixed income markets.
Even though 2022 is expected to bring flat revenue and a contraction in EPS, analysts expect State Street’s business to grow over the next two years. Revenue is expected to reach $13.6 billion in 2024 and EPS $9.33 per share, helped by share buybacks.
HER
Intense competitive landscape
The investment industry is very competitive and more consolidation is expected in the future. Currently, State Street is trailing companies like Vanguard and BlackRock, both offering similar, if not identical, products while showing greater growth opportunities as the threat of losing market share becomes apparent. Especially when you consider a wide range of other competitors, including Charles Schwab (SCHW), Invesco (IVZ), Fidelity and others, all of whom aspire to expand their products and services. Gaining market share is becoming increasingly difficult and State Street’s growth prospects could suffer.
Attractive dividend case
Despite disappointing financial performance, State Street offers a rather attractive dividend investing case. The current yield of 3.25% exceeds the industry average of 3.10%, while still being considered safe, given a Seeking Alpha A- score for safety and consistency. Recently, STT increased the dividend payout by 10%, following a respectable 8.5% dividend growth over 5 years. Dividend growth is expected to continue at similar rates for the foreseeable future, providing dividend growth investors with a strong argument for the stock.
STT’s average number of shares has also declined slightly over the past decade, increasing shareholder returns. The cheap valuation that State Street has been trading at for some time also supports the company’s strategy of continuing to buy back cheap shares, in an effort to support the stock price and use its cash flow efficiently. available cash.
Evaluation
Naturally, the poor performance of stocks in the first 8 months of the year raises the question of whether STT is cheap enough to present a good value opportunity, created by an overreaction of the market. Indeed, State Street is trading near its 10-year lows in terms of the P/E multiple. The current multiple of 9.7x looks very low, given that the stock was trading just short of an 8.0x multiple amid the Covid-19 pandemic. In fact, the stock traded in 2022 at the lowest P/E in 10 years, with the exception of March 2020. The P/B and P/S ratios are also near 10-year lows.
Final Thoughts
After all, State Street is likely to continue to struggle as long as market turmoil persists, and even more so in the event of a broader economic downturn causing investment activity to slow. In the long term, however, the outlook is more optimistic. While passive and active investments are expected to grow and markets will eventually recover, State Street businesses will have the opportunity to persevere. A cheap valuation further increases the long-term attractiveness of the stock.
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