Should you buy KEY’s value proposition?

If there’s one thing that always seems to get investor’s attention it’s any news, rumor or speculation about interest rates. 

I guess that isn’t too surprising  – central banking policy about interest rates has always wielded considerable influence on the financial markets. I think this is a fact that has become even more true over the last decade or so, as central banks across the world all seem to have used interest rates to massage and attempt to manage the markets.

Sometimes I think the Fed’s efforts to walk the fine line between accommodation and restriction in monetary policy is a lot like the child’s story of Goldilocks and the Three Bears. Not too hard, not too soft, the Fed is always looking for that proverbial, “just right” level that allows the economy to grow at a sustainable, yet modest rate.

That pursuit of “just right” gets complicated when conditions mandate more extreme actions. Since early 2022, the Fed has maintained a hawkish tone towards interest rates, raising even when other economists and so-called experts have called for a more dovish tone that at least pauses interest rate increases. Right now, that’s not just about inflations and rising costs, but also about concerns that continued increases will increase stress on a banking system that has been drawing headlines since March.

In the U.S., the much-publicized failures of large, regional banks Silicon Valley Bank (SVB) and Signature Bank put the entire banking industry in a state of rapid decline, with most of the sector dropping to historical lows. That’s especially true for regional banks, where experts and talking heads have speculated that the risk of additional failures may be highest. That fear has only been given more fuel this week as First Republic Bank, which made early headlines but bought time with a $30 billion influx of funds from several of the largest players in the Banking industry, collapsed and saw the majority of its assets sold over the weekend to JP Morgan (JPM). That’s ahead of the Fed’s latest decision on interest rates, which always keeps the market on edge throughout the week of the meeting.

One of the big takeaways I’ve gotten over the past week or so as I’ve conducted my own review of both large and small banks is that, as a number of industry insiders have reported, the failures of those three banks doesn’t actually signal a systemic problem such as the issues that began to surface in 2006 and 2007, eventually pushing the U.S. economy into the Great Recession, and the market into its last true, extended bear market. In fact, while a lot of fear-mongers are pointing at the smaller, regional players as the most exposed, the latest fundamentals from most of the companies indicate exactly the opposite.

Fundamental strength in regional banks also means that the latest drops in price for most of these stocks really just translate to some impressive, and very tempting value-oriented opportunities. That includes companies like KeyCorp (KEY), a mid-cap stock at the bottom of a year-long downward trend that now has the stock only a little bit above its 52-week low. That sets up a very interesting value proposition, so this is a stock that I think is well worth putting in a watchlist at the least. Let’s dive in.

Fundamental and Value Profile

KeyCorp is a bank holding company. The Company is a bank-based financial services company. The Company operates through its subsidiary, KeyBank National Association (KeyBank), which is engaged in providing banking services. Through KeyBank and other subsidiaries, it provides a range of retail and commercial banking, commercial leasing, investment management, consumer finance, and investment banking products and services to individual, corporate and institutional clients. Its segments include Key Community Bank and Key Corporate Bank. Key Community Bank serves individuals and small to mid-sized businesses by offering a range of deposit, investment, lending, credit card, and personalized wealth management products and business advisory services. Key Corporate Bank is a full-service corporate and investment bank focused on serving the needs of middle market clients in industry sectors, which include consumer, energy, healthcare, industrial, public sector, real estate and technology. KEY has a current market cap of $9 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined by -2.22%, while sales increased 38.5%. In the last quarter, earnings increased by 15.8% while Revenues rose by almost 3%. KEY’s Net Income versus Revenue is showing some signs of weakness; over the last year this number was 41.83%, and decreased in the last quarter to 12.83%.

Free Cash Flow: KEY’s Free Cash Flow is very healthy, at about $4.4 billion. That translates to a very attractive Free Cash Flow Yield of 44.27%. It also marks an increase from a year ago, when this number was $2.2 billion.

Debt to Equity: KEY has a debt/equity ratio of 1.92, which is high, but isn’t atypical for banking stocks, which traditionally carry larger debt loads as a normal function of business. As of the last quarter, cash and liquid assets were $10.3 billion versus $22.7 billion in long-term debt. Its impressive Free Cash Flow numbers, healthy liquidity and still-healthy operating margins strong indicate debt management isn’t a concern.

Dividend: KEY pays an annual dividend of $.82 per share, which at its current price translates to a dividend yield of about 7.65%, which is attractive.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at around $15.50 per share. That means the stock is extremely undervalued, with more than 55% upside from its current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The red diagonal line defines the stock’s downward trend from May of last year to its low point in mid-March; it also informs the Fibonacci retracement lines shown on the right side of the chart. That downward trend is really defined mostly by the stock’s decline from a February high at around $20.50, with most of the drop to its low at around $9.50 happening in the first weeks of March. The stock attempted a rally to about $13 to start April, but has picked up momentum again this week. Current support is at the 52-week low around $9.50, with immediate resistance at around $10.50. A push above $10.50 should have limited upside to about $11.50; however a break above that level could see the stock peak at around $13 per share. A drop below $9.50 should find next support at around $8.50, with additional downside to about $7 if bearish momentum accelerates.

Near-term Keys: The stock’s fundamentals are generally strong, and this is a stock with an interesting value proposition. As a mid-cap stock that doesn’t get as much attention from the market as the largest, most notable names in the banking industry, it may not have much short-term upside past $15, but from the stock’s current price, and even on a long-term basis that does look like an attractive price target. If you prefer to work with shorter-term trades, you could treat a break above $11.50 as a signal to buy the stock or work with call options with a near-term target at around $13 per share. A drop below $9.50, on the other hand could be a signal to consider shorting the stock or working with put options with an eye on $7 as a useful profit target on a bearish trade.

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