CM - Buying CIBC Ahead Of Earnings

2023-11-28 13:12:03 ET

Summary

• CIBC stock has lost about 5.75% in the past 3 ½ months, while the S&P 500 gained 1.4%.
• CIBC's upcoming quarterly earnings will disappoint, with lower net income compared to 2022.
• Despite the problems and risks, the dividend is secure and the stock offers attractive cash flows relative to the risk-free rate.

It's been about 3 ½ months since I suggested that Canadian Imperial Bank of Commerce (CM) stock should be avoided, and in that time the shares have lost a total of about 5.75% against a gain of 1.4% for the S&P 500. The company is about to report earnings on Thursday, so I thought I'd review the name yet again as I'm intrigued once more. After all, a stock trading for $38.85 is, by definition, less risky than the same stock trading for $42. In this article I want to build a forecast of upcoming earnings, and, based in part on that forecast, I want to decide whether or not it makes sense to buy or not. The other half of the story is obviously the relative valuation. So, if the relative valuation is acceptable, and the financial forecast is healthy, I'll buy. Otherwise, I'll continue to avoid this name and would recommend others do the same.

My articles have been described as "a bit extra" by some of my younger readers. The tiresome jokes, my tendency to refuse to use 10 words when 100 will do just nicely, my correct spelling and a host of other issues make my writing a bit of a chore sometimes. For that reason, I put a thesis statement near the beginning of each article. This allows readers to get the highlights of my thinking without needing to wade through the whole piece. You're welcome. So, I'm of the view that the upcoming quarterly result will continue the well-established trend this year and will disappoint. For the year, I'm forecasting revenue higher by about 6% and net income lower by about 30% when compared to 2022. Additionally, I think the headwinds I wrote about previously linger. That written, I think the dividend is reasonably secure here, and investors buy cash flows, not price movements. Given the high yield, I think investors are receiving a nice return relative to the risk-free rate, and for that reason, I'll be taking a small position in this stock ahead of earnings. I hope the market reacts negatively to earnings, actually, as it will give me an opportunity to buy even more. There are certainly problems here, but the relative cash flows are too attractive to pass up in my view.

A Recap

I can understand why someone wouldn't want to go through the effort of rereading my earlier article on CIBC. I mean, unless you're suffering from insomnia, my writing can be "a bit much." In order to save you the effort, I'll reiterate the problems I had previously.

First, I was bothered by the fact that residential mortgages now represented about five times the equity of the bank. This is understandable, given the Canadian obsession with residential real estate, but it adds to the risk here. Second, writing of residential real estate, the lack of affordability of Canadian residential real estate poses a significant risk to the bank. Finally, many Canadian real estate bulls have suggested that a crisis can be avoided because Canadian banks will be allowed to simply extend amortization periods. They will not be able to do so, and I quoted an email exchange I had with the Office of the Superintendent of Financial Institutions (OSFI) to demonstrate that fact. For the non-Canadians reading, OSFI is the metaphorical 800 lbs. Gorilla of Canadian finance. They're the people who regulate Canadian banks, and they're the one institution that Canadian banks might be somewhat intimidated by. None of the above has changed, in my view. The regulators are not budging on their opposition to extended amortizations. The price of Canadian residential real estate remains very elevated relative to income etc. Finally, when I write "elevated," I mean prices relative to income that are much farther out of whack than what was seen in the United States between 2006 and 2009.

Financial Forecast

With that trip down memory lane complete, it's time to offer up my forecast of the upcoming quarterly results. Specifically, I'm going to forecast revenue, loan loss provisions, and net income.

I think the most effective forecasts are rooted in history, and in the view that trends tend to continue unless acted upon by a significant outside force. The greater the size of the trend, the greater the size of the outside force required to alter its course. Given my assumptions, I'm going to review recent financial history and assume trends will continue. Specifically, we've seen some patterns over the past three quarters of 2023, and I assume that those are going to continue in the final quarter. Revenue growth has been reasonably good in 2023, in my view. Specifically, it's about 6.3%, 16.9% and 23.6% higher than it was for the first nine months of 2022, 2021 and 2020, respectively. The problem is that everything else has risen at a faster rate, thus lowering net income fairly substantially. Provisions for credit losses, for instance, are about $848 million, or 137% higher, than they were in 2022. In fact, over the past four years, provisions for credit losses at CIBC are up about 66%. This is one reason why net income over the past three quarters was down about $1.516 billion, or 30% relative to the same period in 2022.

So, I'm going to assume the trends continue into the fourth quarter of the year. I'm going to assume that revenue will be higher by about 6%, while provisions for credit losses and net income will be worse by 136%, and 30%, respectively. So, I'm expecting revenue of $5.7 billion for the quarter, provision for credit losses of about $595 million, and net income of around $824 million for the quarter. I've added this forecast to the three quarters we know about already this year, and I present the results in the following graphic for your enjoyment and edification.

So, I think revenue in 2023 will be higher than it was in 2022, but that net income will be significantly lower. Lower-income doesn't necessarily disqualify this stock from consideration, though, as I think the dividend remains reasonably well covered. I'll be willing to consider the investment if the valuation makes sense.

Valuation

"Valuation" is a relative term that can mean a few things. It's about the relative price of a series of cash flows relative to the price of another stream of future cash flows. We generally want to pay the least amount for such future cash flows, so a stock today is considered "cheap" or "expensive" relative to either other stocks or the price paid for cash flows in that stock's own past.

In my view, though, relative valuation also relates to risk. The more risky a set of future cash flows, the more we should discount them. Thus, it's not just about the relative price we pay for a series of cash flows, but the relative risk of one set of cash flows vs. another.

With that out of the way, I'm going to decide whether or not the valuation of CIBC shares is reasonable or not based on the cash flows earned from both the stock and a risk-free investment.

In the table below, I track the cash flows earned on 100 shares of this stock and a Treasury Note, currently yielding 4.355 %. If we assume zero growth in the dividend, an investor in this stock will, over the next decade, receive about 50% more cash than they would from the Treasury Note. That's a reasonable risk premium, in my view. I'm a bond bull at the moment, so I assume that there'll be a chance to earn a decent capital gain on the Treasury Note. The forces that drive the bond higher also will drive the stock higher. In a world where rates drop again, a stock currently yielding just under 6.6% will be quite attractive.

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