CADE - Cadence Bank - Strong Loan Growth And Depressed Valuation Make For A Buy

2023-10-03 04:04:42 ET

Summary

• Cadence Bank offers a solid investment opportunity with strong loan growth and potential for higher earnings.
• The company has a diverse array of services, including commercial loans, and has shown strong growth in its fee income business.
• CADE exhibits a strong upside potential and is currently undervalued, making it a good buying opportunity.

Introduction

The regional bank sector has seen a lot of volatility this year as two of the largest players in the space saw their operations disintegrate as there was a run on the bank. This sent shockwaves through the markets and caused other companies in the space to have their valuations cut heavily. One of these was Cadence Bank ( CADE ) which had the share price go from $27 to $17 in the span of just a few months. Since then it has recovered but still exhibits a very solid investment opportunity in my opinion.

The last report from the company showcased a strong capability in growing the loans of the business and I think this is the main driver behind the last few month's share price appreciation. 16.3% YoY loan growth is not something you brush off, that is incredibly strong and will yield even higher earnings potential for CADE. Given that the bank is also aiming to return a significant amount of it to shareholders as well I think that we are looking at a robust long-term addition to a portfolio with CADE. I like the price and think you are getting a good discount which translates to a buy in my opinion.

Company Structure

Founded in 1876, CADE has evolved into a substantial regional commercial bank and financial services corporation with a presence spanning over 400 commercial banking, mortgage, and insurance locations. Furthermore, it boasts one branch in Illinois and operates a loan production office in Oklahoma. Throughout its long history, the company has expanded its service offerings significantly. Notably, its commercial lending operations have allowed it to provide a diverse array of services, including commercial loans such as term loans and lines of credit.

One of the main appeals behind CADE right now I think is the strong amount of growth it exhibits. The loans grew at double digits YoY and the deposit bade remained robust. The loan-to-deposit ratio for the company remains very good at 84.1%, a level I am comfortable with as it exhibits no significant amount of leverage for the business. But where there is some good news there are also some negative ones as well. The total deposits for the company, for example, saw a decline YoY as the corporate accounts saw less activity, ultimately resulting in a decline of $708 million between Q2 FY2023 and Q2 FY2022. Once the interest rates start to decline though I would expect that the deposit base for CADE will once again start to grow and reflect a higher deposit rate. Lower interest rates make it easier for regular people to more freely spend and move their capital around, and that would most likely yield higher deposit growth for CADE as more capital is readily available for customers and clients. With the last quarter, the cost of deposit did increase which affected the net interest margins negatively, but with loan growth, it did help offset some of that in the bottom line ultimately. I do expect the cost of deposits to remain higher given the current climate, but once rates go down, so would likely the cost of deposits as well.

Earnings Transcript

The CEO of CADE Dan Rollins shared some thoughts and comments on the last quarter of the company in the earnings call the management held on July 25. Below are some comments that I found particularly interesting.

“Mortgage production was robust, supported by second quarter seasonality. Additionally, we saw continued funding from CRE commitments during the quarter. We will continue to fund commitments in the coming quarters, but overall, we expect the pace of loan growth to slow to an annualized mid-single-digit growth rate for the second half of the year”.

The growth of loans came much from improvements in the real estate market as homebuyers became increasingly optimistic and activity made some improvements. With the expectations for 2023 being that loans will show a slower set of YoY growth I think that if it rises to the upside the share price of CADE could significantly move upwards. If there is still double-digit YoY loan growth for CADE, I think it deserves a higher multiple to reflect this, somewhere along the lines of 10 instead, which leaves an immediate upside potential of roughly 15%. Achieving double-digit loan growth when rates are higher is difficult and making it happen is essentially outperforming the rest of the industry in some remarks. A 10x p/e is above the sector and roughly 15% higher where CADE is trading right now as well.

“As we look at a couple of our other highlights, our results reflect strong performance from our fee income businesses, including record quarterly insurance commission revenue of nearly $46 million. We reported a meaningful increase in P&C commissions driven by business growth and retention as well as upward pressure on policy pricing. Finally, we continue to work aggressively towards improving our operating efficiency”.

With strong growth in this part of the business, I think that CADE has done a very good job at diversifying itself and finding investment opportunities when the rates are higher and the city is generally lower. For the coming quarters, I will be looking at the growth of the fee income business. Q2 yielded $46 million in revenues and with elevated interest rates it could improve going into Q3.

Valuation & Comparison

Looking at the GGM model above here I think it becomes quite clear that CADE exhibits a strong upside potential right now. Given that the share price is nearly 15% below my target prices I think it's fair to assume it's a buy right now. The historical growth of the dividend has been higher than my anticipation here, but I think a terminal rate of 4% is still incredibly strong and paints a very good investment picture here. With a p/e of just over 8, it's trading in line with the rest of the sector, but given the solid performance it has had so far, arguing that a higher multiple is applicable is rather easy. Furthermore, the p/b is below 1 right now, a good sign that you do not have to overpay for the balance sheet the company has, making it further appealing to buy right now.

Risk Associated

Amidst a backdrop of economic uncertainties and a deteriorating business confidence landscape, the prospect of loan demand for the latter part of 2023 carries certain risks. It's possible that companies could decelerate or postpone their expansion and growth initiatives due to the prevailing market conditions. The persistently high interest rates further compound this concern, as they may hinder businesses from allocating sufficient capital toward their expansion endeavors. Consequently, this could lead to reduced demand for loans and subsequently lower deposit rates, potentially exerting a negative impact on CADE's bottom line.

Continued high interest rates pose an elevated risk of increasing delinquencies across the United States. If a forthcoming report from CADE indicates a significant portion of their loans turning sour due to rising delinquency rates, it could undoubtedly have a detrimental effect on the company's share price, potentially causing it to trend downwards. This scenario would likely raise concerns among investors, leading to a reevaluation of the company's financial health and prospects. I think that higher interest rates are going to stick around and that of course puts some pressure on the company's servicing loans, CADE for instance now provides competitive rates and has still grown the deposit rates. If there is a failure to do so it will result in a lower valuation. With CADE trading slightly below the p/e of the sector median and a p/b of under 1, I think that the downside is somewhat limited though.

Investor Takeaway

CADE is a strong dividend income opportunity right now as the yield is above 4.5% and the share price depressed in valuation following the volatility the regional banks industry saw earlier this year. This has opened up a strong buying opportunity as the share price is far below the 12-month high of $29 per share.

Last quarter presented strong loan growth and even with single-digit growth expected for the remaining part of 2023, CADE showcases that it is able to grow the earnings potential incredibly well, nonetheless. With robust operational performance and positive outlooks, I will be rating it a buy now.

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