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Morningstar | Stifel's Revenue Growth Is Materially Slowing, but Shares Are Starting to Look Attractive

Revenue growth has materially slowed at Stifel Financial, but the shares are starting to look attractive. For the first nine months of 2018, net revenue increased 5.1% to $2.23 billion. However, third-quarter net revenue of $738 million was only 2.4% higher than a year ago and about flat with the first two quarters of the year. The 9% growth in client assets to a record $289 billion and related increase in wealth management segment revenue have scarcely been enough to offset the fall in institutional trading and financial advisory revenue. Management expects that the fourth quarter will be the best of the year, which is typical for investment banks, and that net revenue in 2019 will be flat to up 13% compared with 2018. We find this range for 2019 plausible, as our base-case net revenue growth estimate is nearly 10%, close to the high end of the range, while environmental factors that are casting a shadow over short- to medium-term results would result in the low end. We don't anticipate making a material change to our $60 fair value estimate for no-moat Stifel Financial, and we assess that the shares are moderately undervalued.

There are many cautionary signs lately, but we believe the market has overreacted. For investment banking, fear of trade restrictions and rising interest rates hurting financing are being cited for stalling acquisition activity. The recently volatile and downward-trending equity markets can also scuttle equity underwriting transactions and weigh on the client assets that power the wealth management business. Net interest income that had been a driver of earnings has materially slowed, because cash balances of clients have in multiple cases decreased banking deposits and net interest margins aren't materially expanding from rising funding costs. That said, on a long-term basis, we still think the shares are moderately undervalued, despite all of these signs of slowing growth and even a potential downturn.

On the margin, there were several positive signs at Stifel. The company completed its acquisition of a bank, Business Bancshares, which will allow more client cash to be swept into Stifel-owned banks. This should increase net interest income growth. The company also had one of its best financial advisor recruiting quarters, adding 31 net new advisors. It seems that the reduction in uncertainty regarding the Department of Labor's fiduciary rule has helped recruiting, while the Securities and Exchange Commission's best-interest standard and some wealth management firms exiting the broker protocol for recruiting haven't severely restrained advisors from switching firms. Finally, Stifel's management said it believes the shares are undervalued, and the firm is likely to step up share-repurchase activity.