SINGAPORE (Dec 2): The Global Portfolio continued to perform very well, gaining 2.7% last week, far ahead of broader market gains. To quickly recap, we have made quite significant changes to the portfolio in recent weeks, which are paying off. We have previously articulated the reasons behind this strategic move — primarily to reflect our upbeat outlook for the US economy and our belief that manufacturing activities globally are turning around and worries over slowing business investments are overplayed.
Last week, we discussed our investment thesis behind the acquisitions of The Boeing Co and building material distributors Builders FirstSource and BMC Stock Holdings. This week, we will share some of our thoughts on the two banking stocks, Comerica and JPMorgan Chase & Co.
Banks are proxies to the overall economic health and are, therefore, the obvious investment choice for our current outlook. With the much-anticipated interest rate cuts by the US Federal Reserve now in the rear-view mirror — and no plans currently for any further moves — the impact on net interest margin (NIM) would have already been fully factored into prevailing prices.
Robust deposits growth, which has risen in the last four straight quarters, is expected to lower the cost of funding for banks. The recent steepening of the yield curve also bodes well. In other words, banks are able to borrow money at lower interest rates and lend at higher interest rates for longer-term loans.
We believe banks that are asset-sensitive and have net interest income (the difference between interest paid on deposits and interest received on loans) as their primary source of revenue will stand to gain the most.
Comerica
CMA is a comparatively small bank with a market cap of just over US$10 billion ($13.7 billion) that fits our profile. The bank has a high proportion of commercial loans, which are mostly based on a floating rate that gets repriced quickly. In other words, its loan portfolio is sensitive to interest rate movements.
Safety-wise, CMA has an average credit rating of upper-medium grade, which makes it one of the most highly rated banks among peers (excluding the large US banks, JPMorgan, Bank of America, US Bancorp and Wells Fargo).
It also has the largest reserves as a percentage of loans within the same group, at 1.27 times. Even among all upper-medium grade banks, CMA’s asset quality, as measured by non-performing assets to total assets, is lower than the average.
Profitability-wise, CMA is one of the most profitable in its class. NIM improved from 2.92% in 3QFY2017 to 3.63% in 3QFY2019, above the industry average of 3.3%.
Among like-sized peers, CMA also has the best returns, with a return on equity (ROE) of nearly 16%, up from 13% in 3QFY2018 and just 10% the year before. Apart from widening NIM, rising returns were achieved through effective cost management. Efficiency ratio — non-interest expenses as a percentage of net income — now stands at 51.7%, down from 52.8% a year ago and 55.5% two years ago.
Valuations are relatively attractive, with trailing price-to-earnings ratio (PER) of nine times, which is 21% lower than the sector peer average. Also, it has an estimated dividend yield of 3.8%, above the average of 2.8% for comparable banks.
JPMorgan Chase & Co
JPM, on the other hand, is the largest US bank by market cap, at a whopping US$414 billion. It is a relatively safe choice within the sector, with global presence and diversified business — in consumer and community banking, corporate and investment bank, commercial banking as well as asset and wealth management. And the bank has performed, delivering revenue and earnings per share growth over the past three straight years, despite tough operating conditions.
ROE improved from 9.6% in 2016 to 12% last year and currently stands at 14.2%. JPM’s asset quality, measured by non-performing assets to total assets, has historically been lower than the industry average.
Underscoring the underlying strength of its balance sheet and cash flow, the company has raised dividends every year for the last eight consecutive years. Current dividend yield is around 2.7%. Its shares are trading at a trailing PER of just about 13.4 times.
JPM reported better-than-expected earnings for the most recent 3QFY2019, with both revenue and profits growing 8% y-o-y — boosted by robust consumer and community banking segment (home loans, auto and credit cards) — which more than offset pressure on NIM. It reported higher net interest income as well as investment banking fees and trading revenue from fixed income. Management raised guidance for the full-year.
The bank’s estimated spending on technology is the highest among the 10 largest regional banks, which should give it a competitive edge through improved efficiency and customer experiences.
Last week’s gains lifted total portfolio returns to 17.5%, the highest since inception. By comparison, the benchmark index is up 13.7% over the same period.
Alibaba Group Holding was our top gainer for the week, up 10.1%. The e-commerce giant made a strong debut on the Hong Kong Stock Exchange, closing 6.6% higher on its first day of trading, giving investor confidence a shot in the arm.
The company has consistently reported strong double-digit sales and profits growth. However, its share price has been susceptible to negative news on the US-China trade war front, even though its operations are primarily in China and Asia-Pacific.
The secondary listing in Hong Kong, closer to its key markets, means that potential investors (especially those in China) are not only familiar with its name but also its products and services. Thus, they are more inclined to give its shares better valuations.
Other notable gainers for the week include Adobe (+3%), BMC Stock (+3%) and The Walt Disney Co (+3.1%) as well as both banking stocks, Comerica (+2.4%) and JPM (+1.9%).
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
