Eye catching results stateside provides an intriguing story of how companies are fairing in the current economic climate. This week we look at two securities owned in our Global Equities portfolio; Regions Financial (NYSE: RF) and Verizon (NYSE: VZ).
It's been an eventful fortnight in global markets, beginning with the coronation of Xi Jinping. The gentleman from Beijing is being rubber-stamped by the National People's Congress (NPC) for an unprecedented third term and officially giving sanction to the now paramount leader and his associated policy agenda, the foremost of which is Covid Zero. On the other side of the Eurasian landmass, Mr Sunak has been installed at 10 Downing Street, which shouldn't be too unfamiliar given his previous residence in Number 11. Both of these will undoubtedly have repercussions for global markets going forward, but we leave that particular discussion for another day. For now though, we look at earnings season stateside and, in particular, two securities owned by our Global Equities portfolio; Regions Financial (NYSE: RF) and Verizon (NYSE: VZ).
Overview of Earnings Season so far
Despite the doom and gloom touted with substantially lower consensus estimates for Q3, the proportion of S&P 500 companies beating expectations in the past two weeks has been rather positive. In fact, of the 19% of companies that have reported, 58% posted positive surprises on both earnings and EPS. Netflix was the major surprise for the market, delivering rather rosy reports along with financials including Bank of America (for recent analysis on Netflix, click here). This also indicates to us a healthier consumer than was previously thought, though at the time of writing, the elephant tech giants have yet to report, with the exception of Microsoft. On the other hand, it was Tesla that has been of concern given the slowing global EV demand (i.e. China and Europe). However, you wouldn't think so given Mr Musk's assertion that he sees the company becoming more valuable than the current leaders Apple and Aramco put together.
The above scenario implies three things for us aside from Elon's irreverent optimism:
On the latter front, it may be a case of the self-fulfilling prophecy with a stronger than expected US economy allowing the Fed to be much more hawkish than would otherwise be the case while at the same time the associated stronger dollar index driving up inflationary pressures and slower growth globally.
The above thesis will be confirmed if strong consumer goods and durable sectors showcase good results while at the same time, companies with a much more global market are showing lacklustre results (discounting for the headwind associated with a higher dollar index i.e. like-for-like earnings in absolute terms).
With that let us move on to two securities that are definitively domestic looking in terms of their businesses. Regions Financial and Verizon.
Regions Financial Corp (NYSE: RF)
For the less familiar investor, Regions Financial is a business that provides retail and commercial banking, mortgage services and capital markets access. Headquartered in Alabama and operating in 16 states across the United States, this has been a story of turnaround since the days of the GFC. While the earnings have been less stellar, underperforming consensus estimates for EPS by close to 20-30%, things get a little more interesting when one looks through the numbers. For one, the EPS miss is primarily the result of a regulatory settlement for legacy issues from the GFC days where it (mis)managed to recklessly sell shares of its riskier high income bond funds in 2007 at inflated prices through some rather creative accounting. Taking this out of the picture, we see the business benefiting from tailwinds across the industry in the form of NII (Net Interest Income). Moreover, unlike counterparts down under, the exposure to residential mortgages makes up less then 15% of the businesses core, which went from 40% of the book at GFC - with the majority now being made up of commercial and the wealth management arms.
Importantly for us given our penchant for liking turnaround stories (especially given the tilt towards value), the company has seemingly learnt from its GFC mistakes in which it had a somewhat near-death experience as a result of uncommercial acquisitions and a significantly lazy balance sheet. The business is now in the upper percentile both in terms of risk (capital adequacy being a stellar 9.5%) with preference for organic growth and bolt on acquisitions specifically limited to wealth management (Enerbank being the latest).
We move next to the all important cost advantages and an interest-bearing deposit beta of 10.5%. The business remains with a low-cost deposit base, upper quartile in operational efficiency. The latter interest beta makes it a rather attractive proposition and allows significant expansion in the margins going forward. To explain, this metric represents the percentage of changes in market rates that the bank has to pass on to customers. In essence, this means that Regions Bank has to in effect only pass on the full extent of rate changes to 10.5% of its customers.
Looking at the numbers further, revenues at $1.87 Billion USD, well ahead of expectations, return on tangible equity in the mid-20’s while the efficiency ratio stands at a stellar 54%. We place the fair value for Region at $25, a 25% premia to the traded price at the time of writing.
To Sum up - A turnaround story that showcases the resilience of the US consumer (at least as it currently stands), with what seems to be little stress despite a significantly hawkish fed.
Verizon Communications Inc. (NYSE: VZ)
We move next to telecommunications giant Verizon, which in much the same manner as her global counterparts, stands in a consolidated, cutthroat and tight-margin industry. The business formed post the mandated break up of Bell System that created the other giant in the wireless space, AT&T. Verizons’ primary bread and butter comes from its post-paid market, where it dominates along with the other big-3 to the tune of 90% of the US market. Though a large customer base requires incremental investment in capacity, given its historical domination and significant footprint, its major costs are either fixed or efficiently absorbed in optimal network utilisation levels.
What makes the business particularly attractive has been its relatively straightforward focus on organic growth as opposed to significant M&A, unlike its competitor AT&T most recently making headlines through its acquisition of Time Warner. While it is true that the business has faced significant headwinds in the fight for market share given its status as incumbent and an arguable race to the bottom in pricing, we think the broader market may have reached an inflection point. While the firm has had a net loss in subscribers to the tune of 300 000 or 1% of the overall base, we think this is largely a result of the gradual increase in pricing that saw pricing increase by 3%. This important metric shows some inelasticity in demand and a lack of immediate substitution. Moreover, in our view, the loss in post-paid retail customers was more than offset by wins in the business segment that should have consistent longer-term earnings and provide greater visibility. Comparing this to industry competitor AT&T, the business has for the first time beat their rival delivering 2.6 Million new gross post-paid customers.
Looking at the numbers, ROI on invested capital is running at 17% (based on our calculations), with the business having realised $30 Billion in proceeds to shareholders since 2005. However, this comes with the caveat that the spinoffs that resulted from the company washing its hands of various assets have had a marked history of bankruptcy (i.e. they have had a knack for being too good a negotiator when selling!). The business continues to invest heavily in its capacity, including over $22 Billion USD in C-Spectrum in 2022 alone.
To Sum Up - Great business with some short-term pain as the market seems to misunderstand the implications of the numbers both in terms of subscriber growth and strategy.
Disclaimer: RF.NYSE and VZ.NYSE are currently held in TAMIM portfolios
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.