Drip
Portfolio Report
Thursday, June 4, 1998
by Dale Wettlaufer ([email protected])
Alexandria, VA (June 4, 1998) --Today we wrap up our look at First Tennessee National Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FTEN)") else Response.Write("(Nasdaq: FTEN)") end if %>. If the company is included in our final list of five or six companies, we'll take a closer look at things at that time.
Relating some of the company's strategies to the company's financials that we reviewed in our first look in early May, there are a couple things that I would like to point out.
The first, again, is the company's asset turnover. This measures how long it takes for a dollar of assets to become a dollar of revenues. If assets turn over once a year, then it takes a year for a dollar of assets to become a dollar of revenues. But bank assets turn over much more slowly, at about 6% per year. That means it takes almost seventeen years for a dollar of assets to become a dollar of revenues. What we want to see is a much more active asset base, because it takes fewer dollars of assets, and thus capital (depending upon the riskiness of those assets) to generate a dollar of sales. Remember, the intelligently run bank or financial services company (or really, any company) doesn't measure its success on absolute levels of net income or assets it can generate. It measures its success according to the risk it takes on to generate its earnings and how much capital it has to tie up to generate a dollar in net income.
For the country's largest financial services companies, we see that the average asset turnover ratio is 6.09% per year, and 6.18% per year taking goodwill out of the asset denominator in the ratio (see the Spreadsheet Guide for definitions). For mid-size banks, asset turnover runs slightly lower at 5.96% to 6.00% per year. The superior companies in the universe of banks that I follow are:
America Express <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AXP)") else Response.Write("(NYSE: AXP)") end if %>.....14.74%
Charles Schwab <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SCH)") else Response.Write("(NYSE: SCH)") end if %>......14.47%
Mellon Bank <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MEL)") else Response.Write("(NYSE: MEL)") end if %>.....9.16%
Norwest <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOB)") else Response.Write("(NYSE: NOB)") end if %>.....8.48%
First Tennessee.....8.46%
Wells Fargo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WFC)") else Response.Write("(NYSE: WFC)") end if %>.....8.02%
Citicorp <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCI)") else Response.Write("(NYSE: CCI)") end if %>.....7.7%
U.S. Bancorp <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: USB)") else Response.Write("(NYSE: USB)") end if %>.....6.81%
Depending on other factors such as margins and leverage, asset turnover can be the most decisive factor in a company's total return on capital. Most often, a high turnover financial services business operates with lower margins, though. So the next thing we want to look at is return on assets (ROA), which is a primary measure of a financial services firm's profitability. Return on assets equals asset turnover multiplied by net margin. ROA of 1.2% is the lowest measure of profitability that I would accept in a normal year for a bank. For First Tennessee, the company's ROA2 (which takes amortization of goodwill out of the expense denominator) on a trailing basis is 1.462%, which means that its asset turnover does not offset its lower-margins:
Asset turnover (taking goodwill out of average assets) of 8.46% multiplied by net net margin2 (taking amortization of goodwill out of expenses) of 17.29% = ROA2 of 1.46%
How, then, does First Tennessee reach excellent ROE2 of 23% and amortization-adjusted return on equity (taking goodwill out of the asset base and goodwill amortization out of expenses) of 25.5%? The company uses higher-than-average leverage. Among larger banks, average assets to average equity averages 13.88 and average tangible assets to average tangible equity averages 15.11. First Tennessee's average assets to average equity ratio for the trailing four quarters was 15.87, and its average tangible assets to average tangible equity ratio was 17.44.
The one thing that I don't really like about First Tennessee is the fact that its financials are so affected by Financial Accounting Standards Board Statement of Financial Accounting Standards No. 125 (FAS 125). You want to talk about a confusing accounting concept? I personally don't at the moment because it's very difficult to understand and communicate properly what it's all about.
For now, we'll leave off by pointing out that First Tennessee has some attractive features but is pouring back into the business a huge amount of money to achieve its growth. The company has been cash flow negative, and last quarter it generated negative cash flow of over $1 billion. So, its 21% growth in EPS comes at some risk. We'll be dealing with the FAS 125 issue more comprehensively when we look at Norwest <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOB)") else Response.Write("(NYSE: NOB)") end if %> and if First Tennessee makes it into the "Final Six."
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