January 15, 2018 - 6:59pm EST by
2018 2019
Price: 107.00 EPS 5.98 6.40
Shares Out. (in M): 230 P/E 17.9 16.7
Market Cap (in $M): 24,610 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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Based in Chicago, Illinois, Northern Trust (“NTRS”) is a financial holding company that provides wealth management for individuals, families and private businesses, and asset servicing and asset management solutions to institutional clients on a global basis.  Founded in 1889 by Byron Smith, NTRS has evolved into a premier, and prestigious, financial service provider and advisor to ultra-high net worth families, investment funds and sovereign wealth funds.  Currently, NTRS has $9.7 trillion of assets under custody/administration and $1.1 trillion of assets under management.  The company’s market capitalization is approximately $24.6 billion, relatively small for a globally-branded banking franchise.


I find the following business and investment dynamics of NTRS attractive:


Prestigious brand with a conservative reputation.  Since its founding in 1889, the Smith Family has created and fostered a conservative management style that itself has driven the prestige and brand value that the company enjoys today.  Having declared its initial dividend in 1896, the company has paid a regular dividend ever since, including through the financial crisis of 2008-9.


Growing, attractive target markets.  NTRS’s target markets – North American private wealth management (~45% of consolidated net income) and global institutional asset custody/advisory (~50% of net income) – are both massive in scale and growing organically.  In its wealth management division, NTRS focuses on the high- and ultra-high net worth markets, which are estimated to grow at high single digit rates.  Prior to recent rate hikes, operating margins in this segment remained robust (36% in 2015, up from 33% in 2014) despite compressed interest income.  Rising rates should cause margins to expand further in 2018 and 2019.  There are scale economies in wealth management, and while NTRS is particularly strong in the Midwest and Southeast markets, it has just recently begun a meaningful push into New York and the Northeast.  In the corporate & institutional segment, there are organic and acquisition-related opportunities for growth, particularly in the fund services and administration business where the trend toward outsourcing of back-office functions continues.  NTRS also has a nascent ETF business (FlexShares) that is growing.


Expense moderation.  Management had been successful in reducing its key ratio of non-interest expenses to trust & investment fees (the primary measure of the factors management can most directly control) from 2011 through 2015, creating a significantly improved cost structure that could be leveraged as the business climate improved.  While this metric has essentially flatlined since 2015, the company has been investing to drive growth in new markets, and further progress seems likely if the company is successful in winning new client business.  In October, the bank announced a new $250 million cost reduction initiative.


New, quantitatively-minded CEO.  NTRS reported very disappointing second quarter earnings, owing to both weaker-than-expected net interest income and poor core expense management.  Unlike money center banks (e.g. Bank of America) that tend to have low deposit betas and large retail customer bases, NTRS’s customer base skews heavily institutional and ultra-high net worth, forcing the bank to pass through a somewhat larger portion of rising rates.  In October, CEO Frederick Waddell announced his retirement and the board appointed Michael O’Grady to take his place, which makes sense given the new cost savings program.  As Waddell said on the third quarter earnings call, “I would say he's the Harvard MBA, so he's the numbers guy. And I'm the Kellogg MBA; I'm the marketing guy. So yes, if you want to read a little nuance into that, Mike is different for all the right reasons. And he will bring a fresh set of eyes.”


Deregulation and capital return.  In late June, the Wall Street Journal reported that trust banks such as NTRS could benefit from deregulation under Trump’s Treasury Department, which is seeking to exclude safe, liquid assets from the leverage ratios of trust banks, potentially freeing up over 30% of their assets, theoretically increasing earnings power.  And on June 28th, NTRS announced that the Federal Reserve had not objected to its 2017 Capital Plan, which allowed the dividend to rise to an annualized $1.68 (up 50% from pre-crisis level) and the company to repurchase up to $750 million of its stock in the next year.


Consensus 2019 EPS for NTRS looks presently to be $6.40 (16.7x current implied valuation), though with rising rates, stable equity markets and a new focus on costs from the new, quantitatively focused CEO, these numbers appear conservative to me.  At ~20x potential 2019 EPS of $7+, NTRS shares could trade up 30-40% over the next 12-18 months to $140, plus dividends.  Should bank M&A start to pick up again in a newly-deregulated environment, NTRS could also prove to be a very attractive and accretive target for a larger bank seeking to build scale in the coveted ultra-high net worth markets.


Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein.  Please do your own research.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


-- Rising interest rates coupled with stable equity markets.

-- Cost savings execution by new CEO.

-- Deregulation and capital return.


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