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Why Did State Street's Stock Rally Despite Weaker Earnings?

Why Did State Streets Stock Rally Despite Weaker Earnings?

-EPS was down 8% y-o-y.

-Total revenue fell by 4%, to $3 billion, and down 1% ex adjustments. Fee revenues were down 6% due to lower equity and fixed income. FX trading partially offset the lower fees.

-Expenses were largely flat for the year at $2.1 billion.

-Pre-tax margin was 28% down 3% y-o-y.

-Return on equity came in at 12% for the quarter.

State Street (NYSE: STT) is a financial services firm that provides asset management, custodian services, fund accounting, and administration services. Global Services handles assets from many classes, including stocksderivativesexchange-traded fundsfixed income assets, private equity, and real estate. State Street administers 40% of the assets under administration in the US mutual fund market. Global Services also provides outsourcing for operations activities and handles US$10.2 trillion of middle-office assets.

Despite weaker earnings, State Street's stock rallied during market hours, as results were better than expected. State Street's business model should stabilize as we move forward, and investors clearly understand that despite the weak results for the quarter, the company is in a far better position than Wall Street expected.

State Street continued to onboard new clients for the quarter, but the sell-off in equity and fixed-income markets partially offset net new business and client fees. As a result, AUM fell by 10% y-o-y. Back office servicing fell by 7%, ex. FX servicing fell by 4%. Management fees were down 3% and down 1% ex. FX. Front office and software data business fell by 15% y-o-y. New bookings came in at $11 million and ARR came in at $251 million, with an installed revenue backlog coming in at $96 million.

Expenses fell by less than 1% and GAAP expenses came in at $2.1 billion. Capital ratios increased by 12.9%, and tier leverage increased to 6%. CET1 capital came in at $14.9 billion and risk-weighted assets came in at 115. An increase in capital ratios should help the company reduce risk, and investors will take this into consideration should they decide to invest in the stock.

Market outlook for State Street

Equity and bond markets continue to be under pressure as record inflation has pushed the Federal Reserve to raise rates consistently, and considering that inflation has not come down during the last couple of months, markets are expecting multiple rate hikes starting with another 75 bps hikes in July.  Rates could go as far up as between 300-400 bps, which would send the 10-year treasury closer to 4%. That would likely bring down equities and bond prices further. And many analysts expect that the S&P 500 could go as low as 3000, which would add pressure to earnings. Competitors such as Fidelity (NYSE: FIS) are also expected to take a hit on earnings as volumes and assets have both declined.

As rates go higher, not only are equity valuations likely to correct, but as interest rates head higher, earnings are likely to slow down as well, since costs such as interest rates would increase and demand would soften.  Although State Street’s business model remains relatively strong, fees are going to be negatively affected and trading volumes are likely to be down for at least a couple of quarters.

The company currently trades at a relatively cheap valuation, with price-to-earnings coming in at 8x. The stock is likely valued at intrinsic value and is likely to remain around current levels until the equity markets stabilize. Although the stock is cheap, it could head down further, especially if volatility increases.

Analyst’s outlook

Analysts are currently projecting a median target of around $76 for the stock, representing a valuation that would be 27% higher. The latest analyst reports have lowered their targets to $65 in their latest reports.

State Street is a stock that is a relatively robust business despite its exposure to the financial markets. The mutual fund and asset management industry are likely to be resilient unless a serious financial event occurs. Therefore, the long-term prospects for the business remain intact.

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