State Street is up around 50% in 2013, quite a move for a relatively boring financial company with no major business breakthroughs.
The biggest reason for STT’s advance has been a catch-up in valuation from what was arguably an undervalued stock. Regulatory and interest income overhangs had discouraged investor interest, and State Street’s disastrous exposure during the financial crisis had likely shrunk the investor base as well.
In any case, the company has grown earnings about 7% so far in 2013, practically all due to a lower share count (revenues are up 3%) as a result of its stock buyback program. Having said that, valuation was at quite a low level last year compared to most other stocks in the broader market with a similar growth rate, so the catch up in stock price is more reasonable in that context:
In fact, at 15x with expected earnings growth of 10-15%, State Street still looks more reasonably valued than most stocks today.
One hitch is that State Street’s earnings are quite exposed to asset prices as a whole. State Street has 2 main businesses – Investment Servicing and Investment Management. Both businesses have benefitted from higher fee income as global asset prices have risen. For a sense of the sensitivity of the business to such price moves, here is the company’s assessment:
we estimate, assuming all other factors remain constant, that a 10% increase or decrease in worldwide equity valuations would result in a corresponding change in our total revenue of approximately 2%. If fixed-income security valuations were to increase or decrease by 10%, we would anticipate, assuming all other factors remain constant, a corresponding change of approximately 1% in our total revenue.
Overall, that’s less of an impact than I would have feared.
Another catalyst for the change in sentiment this year was the move higher in interest rates in 2013. While that has not had an immediate impact on STT, higher rates over time could help its interest income.
The stock’s uptrend this year has been very impressive. STT really got going when it broke out to new bull market highs above the 53-54 area in January, and has held that breakout ever since. The shorter-term chart shows higher highs and higher lows, including the most recent break above the July high of $71.21:
[caption id="attachment_32679" align="alignnone" width="600"]
STT daily, 200 day ma in black, Courtesy of Bloomberg[/caption]
The stock’s breakdown back below $71 is concerning in the short-term, but I like the relative valuation and the stability in STT’s business in the long-term, so I’m more interested in looking for a spot to buy on the dip.
The $64-$66 area would be ideal, but nothing to do for me for now. If it does get down there, I like the following trade:
(This structure is only one we’d consider on a pullback, but laying it out here for those interested)
Potential Trade Structure: STT Buy the Feb 67.50 / 72.50 Call Spread
-Buy 1 Feb 67.50 Call
-Sell 1 Feb 72.50 Call
Trade Rationale:
STT’s recent high was around 72.50, so the trade is targeting a move to that level (from the presumed entry level in the 64-66 area). February expiry captures the next earnings report, as well as the potential volatility from more political maneuvering around the debt ceiling. STT has found resistance in the 70-72.50 area twice now in the past 4 months, so we do not want to enter a new long delta position today.