CM:CC - Canadian Imperial Bank of Commerce: Strong Business Despite Weaker Profits

2023-10-02 17:07:30 ET

Summary

• Canadian Imperial Bank of Commerce is one of Canada's six largest banks with substantial scale.
• Higher interest rates and a slower Canadian economy are leading to expectations of possible higher provisions for credit losses.
• Higher U.S. Treasury yields could also be a headwind for the valuation.
• Nevertheless, the bank trades for a pretty attractive price to tangible book value ratio given its quality and growth potential in the long term.

Canadian Imperial Bank of Commerce ( CM ) is one of the six largest banks in Canada.

In 2022, 36% of the bank's reported net income came from its Canadian Personal and Business Banking business, 30% came from Canadian Commercial Banking and Wealth Management, and 31% came from capital markets. 12% of net income came from U.S. commercial banking and wealth management and the company's other businesses accounted for a -9% reported net income distribution.

In Q3 2022, Canada accounted for 72% of net income, and the U.S. accounted for 15%.

With the growth of the Canadian economy and also to a lesser extent, the growth of the U.S. economy, Canadian Imperial Bank of Commerce's annual normalized diluted EPS in U.S. dollars has grown in the long term.

Tangible book value per share has also grown over the long term in terms of U.S. dollars.

EPS slowdown

In recent years, the bank's profitability has decreased slightly from 2021.

Adjusted EPS was C$5.96 in 2019, C$4.85 in 2020, C$7.23 in 2021, and C$7.05 in 2022.

In terms of the current U.S. dollar and Canadian dollar exchange rate, the adjusted EPS for those years in U.S. dollars would be $4.39 in 2019, $3.57 in 2020, $5.32 in 2021, and $5.19 in 2022.

Analysts are projecting EPS of annual earnings per share of $4.97 for the fiscal period ending October 2023, and $4.95 for the fiscal period ending October 2024.

Given the estimates, analysts are expecting profits to moderate a bit.

Canadian Economy

A slowing Canadian economy is likely one big reason for the expected profit moderation.

Given Canada is Canadian Imperial Bank of Commerce's most profitable market, the company's profits have experienced headwinds.

Due to inflation, Canada's central bank has raised the overnight interest rate substantially in the past year and a half to an overnight interest rate of 5% as of September 6 from near 0% to 0.25% in the beginning of 2022. The higher interest rates have made growth harder.

With the higher interest rates as a headwind, Canada's economy unexpectedly contracted at an annualized rate of 0.2% in the second quarter and the country's economy is currently growing at a rate of a little under 0.5% annualized for the third quarter, although the period isn't completely over in terms of when the data was measured.

Q3 2023

Canadian Imperial Bank of Commerce's Q3 2023 results reflect some headwinds.

For the third quarter, sales rose 5% year over year to C$5.85 billion. Adjusted net income, however, fell 15% year over year to C$1.473 billion. Adjusted diluted EPS fell 18% year over year to C$1.52.

The banks' profits declined in part due to higher provisions for credit losses given tougher economic conditions could lead to more write-downs.

In Q3, the company's total provision for credit losses C$736 million compared to C$438 million in Q2 2022. Provisions on impaired loans were C$478 million, an increase of C$99 million quarter over quarter with the bulk being due to the company's U.S. office commercial real estate exposure.

While profits declined, the bank's balance sheet strengthened, however.

In terms of its balance sheet, the company has a common equity tier 1 ratio of 12.2% for Q3 2023, up from 11.8% in Q3 2022 and 11.9% in Q2 2023.

Office Market

In the United States, office space has come under pressure due to work from home trends and many analysts expect office space values to fall significantly in the coming years.

In terms of exposure to the U.S. office market, Canadian Imperial Bank of Commerce is actually pretty well positioned with the bank's exposure to the U.S. office sector at less than 1% of the bank's total loan portfolio.

For Q3 2023, commercial real estate, of which office is a segment, accounted for 11% of Canadian Imperial Bank of Commerce's overall loan mix.

Valuation

Given provisions that credit losses affect earnings substantially, and quarterly provisions for credit losses depend on economic conditions that can be unpredictable, Canadian Imperial Bank of Commerce's earnings can fluctuate pretty significantly in the near term depending on how the Canadian and U.S. economy does.

With the economy in Canada and the United States more uncertain given the higher interest rates, it might be more prudent to view the stock based on its price to tangible book value ratio.

If tangible book value per share is accurately stated (some banks have in the past not accurately stated tangible book value per share), tangible book value per share can be correlated with normalized earnings power per share, although there are obviously many other factors that also affect earnings as well.

As it stands, Canadian Imperial Bank of Commerce's price to tangible book value ratio is pretty attractive as it is near the 2020 lows.

One big reason for the lower price to tangible book value ratio is higher U.S. Treasury yields which has made the bank's dividend not as attractive as before.

Although Canadian Imperial Bank of Commerce currently has an annual dividend yield of around 6.62%, the 10-year U.S. Treasury yield is 4.57% and the 30-year U.S. Treasury yield is 4.7%.

If U.S. Treasury yields go higher, the bank's price to tangible book value ratio could potentially come under more pressure.

Some investors think U.S. Treasury yields could go higher given factors such as some big economic countries such as China could possibly sell U.S. Treasuries . Some emerging market countries are also trying to use less U.S. dollars which could weaken U.S. Treasury demand more than it otherwise would have been.

Some investors, however, think U.S. Treasury yields might not go higher and could go lower as the effect of interest rate increases eventually passes through the economy.

Risks

Higher U.S. Treasury yields could depress the bank's valuation.

Depreciation in the Canadian dollar versus the U.S. dollar could make the bank's earnings lower in U.S. dollars.

A slowing Chinese economy could slow the Canadian economy given China is a big commodity importer and the commodities sector in Canada is considerable.

Economic conditions in Canada could worsen, and the bank could have to make higher provisions for credit losses as a result and possibly earn less adjusted EPS.

Canada's housing market could worsen if the central bank raises rates too far and economic conditions worsen too much. According to the St. Louis Fed, the average residential property prices for Canada were negative in Q1 2023 and Q4 2022, the first negative since 2009. A weaker Canadian housing market would be a headwind for earnings if the sector weakens too much. For Q3 2023, 51% of Canadian Imperial Bank of Commerce's portfolio was mortgages.

The U.S. economy could worsen and be a headwind for the bank's U.S. business.

Long Term

Canada has a lot of potential as a country given its relatively small population and substantial land area. Canada also has one of the most advanced economies in the world. Although there could be near-term downside due to various macro headwinds such as inflation, a weaker economy, and higher Treasury yields, the long-term is still pretty attractive.

Canadian Imperial Bank of Commerce is a pretty high-quality bank with scale, a strong brand, and a general history of profitability.

With a price to tangible book value multiple of 1.7, which is around the bank's 5-year median for that statistic, a target price of slightly over $50 per share in a few years would be reasonable assuming tangible book value per share is $30. If tangible book value per share is higher, the target price could also be higher.

It could take a few years for macro conditions to normalize enough, however, and the bull case will depend on the Canadian real estate market normalizing.

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