Investors looking for income in the coming years may want to look at Bank of America (BAC) shares, given CEO Brian Moynihan's comments at the company's investor conference yesterday.
While Moynihan admits BAC is not yet running on all cylinders, he insists the company is moving in the right direction. Divisions such as Wealth Management could begin to reach normalized earnings by the second half of 2011, while the bank's Deposits and Home Loans businesses may take until 2013 or 2014 to reach normalized earnings.
Once BAC has completely worked through all its issues, Moynihan says that Bank of America's normalized earnings should be between $35-40 billion on a pretax basis -- an astonishingly large number given the $150 billion market cap the market is assigning BAC. With no plans for balance sheet growth, M&A, or earnings retention, that leaves a lot of excess cash that Moynihan says is destined for shareholders.
Throughout the presentation, there were numerous references to the bank doing a better job creating value for shareholders. This is an important goal, given the amount of pain shareholders suffered after BAC's previous management bought Countrywide and Merrill Lynch, both of which it probably could have paid less for had it been less aggressive. Add to that dilution from TARP re-payment, and the mortgage mess, and shareholders have had a lot of negative news to deal with.
The company plans on raising the dividend modestly in the second half of this year, until it eventually equals about 30% of earnings. Chris Mutascio, a Stifel Nicolaus analyst, estimates that -- assuming a 35% tax rate on $37.5 billion in pretax earnings, and 10 billion shares outstanding -- normalized earnings can approach $24.3 billion, or $2.43/share. Using his estimates, and compounding that with the bank's projection to raise the payout ratio to 30% of earnings, dividends based on normalized earnings should total about $0.73.
The presentation Moynihan gave also pointed to special dividends and share buybacks as other means to enhance shareholder value. This fact, along with another slide that said the bank will not use cash for M&A, to grow the balance sheet, or to retain significant amounts, leads to some interesting scenarios for what BAC will do with the approximately $1.70/share in earnings, or approximately $17 billion, that will not be paid out as ordinary dividends each year. If share prices remain close to book value, expect the bank to buy back large amounts of shares, undoing some of the dilution shareholders suffered when BAC issued shares to repay TARP. Should the share price run up significantly higher than book value before normalized earnings are attained, large special dividend checks may be showing up in shareholder's mailboxes. Either way, shareholders stand to be rewarded once the bank can reach normalized earnings.
Shares of BAC ran up almost 5% yesterday on Moynihan's comments, and are in the middle of their 52-week range. Trading at $14.69, shares are currently at six times the projected 2013 normalized earnings of $2.43/share; quite cheap compared to the roughly 15 times earnings the S&P 500 is trading for currently.
Assuming BAC can hit the metrics laid out above, and attaching a conservative PE of 12, shares could go as high as $29 over the next two or three years. At that level, the $0.73 ordinary dividend would give shares a 2.5% yield. Factor in special dividends and share repurchases, and the total return to shareholders over the next three years will be even higher.
Bank of America shareholders have suffered greatly over the last four years, but the next 24-36 months should see patient investors rewarded.
Disclosure: I am long BAC.
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