It has been about a month since the last earnings report for State Street (STT). Shares have lost about 10.1% in that time frame, underperforming the S&P 500.
Will the recent negative trend continue leading up to its next earnings release, or is State Street due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important catalysts.
State Street Q3 Earnings & Revenues Miss, Expenses Up
State Street's third-quarter 2018 earnings of $1.87 per share missed the Zacks Consensus Estimate by a penny. Nonetheless, the figure was 13% above the prior-year quarter level.
Results reflected higher net interest income (reflecting rise in interest rates) and fee income (indicating higher trading services income and management fees), which supported revenue growth. Also, improvement in assets under custody and administration, and AUM acted as a tailwind. However, increase in non-interest expenses was an undermining factor.
Net income available to common shareholders was $709 million, up 12.7% from the year-ago quarter's figure.
Revenues Improve, Expenses Rise
Total revenues were $2.95 billion, increasing 3.7% from the year-earlier quarter's count. However, the top line marginally lagged the Zacks Consensus Estimate of $3 billion.
Net interest revenues increased 11.4% from the year-ago quarter to $672 million. This upside was mainly driven by higher interest rates and an increased client engagement across cash products and a disciplined liability pricing. Also, net interest margin expanded 13 basis points year over year to 1.48%.
Fee revenues inched up 1.7% from the prior-year quarter to $2.28 billion. This uptick was aided by higher management fees and trading services revenues, partially offset by a decline in servicing fees, securities finance revenues and processing fees plus other revenues.
Non-interest expenses were $2.08 billion, up 2.9% on a year-over-year basis. The rise was due to increase in all expense components except occupancy costs.
As of Sep 30, 2018, total assets under custody and administration were $34 trillion, up 5.9% year over year. Moreover, AUM was $2.8 trillion, up 5.1%.
Strong Capital and Profitability Ratios
Under Basel III (Advanced approach), estimated Tier 1 common ratio was 14.0% as of Sep 30, 2018, up from 12.4% as of Jun 30, 2018.
Return on common equity came in at 14.0% compared with 13.0% in the year-ago quarter.
State Street Beacon
Given the continued challenging environment, State Street is accelerating its multi-year plan to further digitize its operating environment and create cost efficiencies. The company announced a multi-year plan to accelerate the next phase of its transformation program aimed at generating roughly $550 million in annualized pre-tax savings and improve operating basis pre-tax profit margin to 33%. Notably, the company is on track to complete the initiative by early 2019, significantly ahead of scheduled target of 2020-end.
State Street generated $180 million, $150 million and $175 million in pre-tax expense savings in first nine months of 2018, 2017 and 2016, respectively. The company now targets to achieve $200 million in annual pre-tax net run rate expense savings in 2018 (up from prior target of $150 million).
Also, the company reached its operating basis pre-tax profit margin target of 31% in 2017 (ahead of scheduled 2018-end). In order to implement State Street Beacon, the company anticipates incurring aggregate pre-tax restructuring costs of approximately $300-$400 million.
Outlook(excludes any contribution from acquisition of Charles River Development)
State Street will be providing financials primarily on GAAP basis this year, while presenting certain non-GAAP measures such as pre-tax margin as well as additional notable items including acquisition restructuring costs in line with industry practice.
Starting 2018, on a perspective basis, the new FASI revenue recognition standard takes effect, under which certain costs previously presented on a net basis will now be represented on a gross basis. Hence, management expects revenues and expenses to increase nearly $225 million.
NII is anticipated to grow within a range of 10% to 13%, reflecting higher expected interest rates. Further, balance sheet growth will mainly depend on new business and related client deposit activity.
Management expects fee revenues to rise in the range of 7-8%, attributable to decent equity market growth and continued low volatility trading divisions.
The company anticipates swap cost to moderate following the changes in the currency mix of balance sheet. Hence, processing fees and other revenues will be in the range of $35-$45 million on a quarterly basis.
Further, the company projects positive fee operating leverage in the 75 to 150 basis points range and reflects focus on both investments and expense management. Management expects to see variability across quarters, with continued focus on expense management.
In addition, on a GAAP basis effective tax rate is estimated to be in the 15-17% range.
Fourth Quarter 2018 Outlook
We expect fourth-quarter 2018 servicing fee revenues to be flat sequentially on the assumptions of continuing industry conditions and stable market levels. Further, sequential NII growth is projected, though it always depends on market rates and betas.
Total expenses are anticipated to be marginally above third-quarter levels. Notably, this is consistent with the company's expectations to keep second-half 2018 expenses flat compared to the first half.
How Have Estimates Been Moving Since Then?
In the past month, investors have witnessed a downward trend in fresh estimates.
Currently, State Street has a nice Growth Score of B, a grade with the same score on the momentum front. Following the exact same course, the stock was allocated a grade of B on the value side, putting it in the second quintile for this investment strategy.
Overall, the stock has an aggregate VGM Score of A. If you aren't focused on one strategy, this score is the one you should be interested in.
Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. It's no surprise State Street has a Zacks Rank #4 (Sell). We expect a below average return from the stock in the next few months.