COLB - Columbia Banking System's Stock Underpriced Due To Market Overreaction

2023-06-06 02:57:53 ET

Summary

• Columbia Banking System is undervalued by 24% at its current price of $22.07, with a fair value of $28.87 according to a discounted cash flow analysis.
• The bank's merger with Umpqua is expected to create accretive value and improve portfolio diversity, with cost synergies of over $135 million by Q3 2023.
• These factors, in addition to Columbia's strong balance sheet, lead me to rate the company a 'buy'.
• Risks for Columbia include continued interest rate volatility and potential bank crisis contagion, though the bank has largely avoided the worst of recent collapses.

Columbia Banking System ( COLB ) is a Tacoma, Washington-based regional bank, with operations across the Western US. Via its own brands and subsidiary Umpqua's, Columbia offers a variety of banking services, ranging from retail and commercial banking to wealth management and private banking.

The bank's successful execution of these practices has enabled significant QoQ net interest income growth, in line with Columbia's scale priorities.

This combination of asset quality, the bullish merger with Umpqua, and a general undervaluation lead me to rate Columbia a 'buy'.

Introduction

In its Q1 presentation, Columbia presents a full-year outlook on its expected performance through the 2023 fiscal year. In the coming period, Columbia expects an expansion of average earning assets, accelerated accounting accretion in across loans and securities, and temporary cost increases related to M&A and amortization costs.

This reflects Columbia's wider strategy of integrated, accretive scale growth alongside the focus on high quality, interest generating assets.

Valuation & Financials

General Overview

In the TTM period, Columbia- down 27.95%- has experienced middling performance, between the broad market, represented by the S&P 500 ( SPY )- up 2.52%- and the regional banking index ( KRE )- down 34.80%.

The steep decline in Columbia and KRE's price is largely a symptom of rising interest rates and the subsequent collapse of First Republic Bank, Silicon Valley Bank, and a number of regional banks.

However, I believe the market is unfairly punishing Columbia, which sustains a strong balance sheet not prone to the financial weakness of peer banks.

Comparable Companies

The regional banking industry is inherently a fragmented one, with different banks for different regions and high levels of competitive intensity, from mega-banks such as JPMorgan Chase ( JPM ) and Bank of America ( BAC ), other medium to small banks, and credit unions. As such, the most comparable firms to Columbia are similarly sized regional, US-based banks. This includes Puerto Rico-based Popular ( BPOP ), which serves Florida and California among other markets, Bank OZK ( OZK ), which maintains a presence across 8 states, most notably Arkansas and Georgia, the Midwest-centric United Bankshares ( UBSI ), and Georgia-based Synovus Financial ( SNV ).

As demonstrated above, Columbia has experienced the second-poorest quarterly and yearly performance, in spite of strong shareholder returns and multiples-based value propositions.

This chronic underperformance extends to Columbia's 5-year performance with returns approaching -49.39%, despite above-average scale growth, with 5-year revenue growth approaching 53.93%.

Moreover, with the best-value forward P/E ratio, the second-highest profitability, and the lowest P/B, Columbia manifests its undervaluation relative to peers.

Alongside strong investor returns via its 7.04% dividend, Columbia additionally maintains a judicious capital deployment strategy. The combination of the aforementioned value and its shareholder prioritization makes Columbia an ideal pick.

Valuation

According to my discounted cash flow analysis, at its base case, the fair value of Columbia is $28.87, meaning the stock is undervalued by 24% at its current price of $22.07.

My model, calculated over 5 years without perpetual growth, assumes a 10% discount rate, pricing in recessionary risk, banking risk, and the increased cost of capital. Additionally, I conservatively calculate revenue growth moderately lower than historical levels, pricing in the macro headwinds prevalent over the past few years.

Alpha Spread's multiples-based valuation tool supports my thesis on the company's undervaluation, projecting, at its base case, that Columbia is undervalued by 38%, meaning the stock's fair price is 38%.

Thus, using an average of my DCF's valuation and Alpha Spread's relative valuation, the fair price of Columbia is $32.28, meaning the stock is underpriced by 31%.

Columbia's Merger Creates Accretive Value; Balance Sheet Remains High-Quality

Columbia's M&A activity has culminated with the merger with Umpqua, underlining the company's focus on producing expense reductions alongside scale growth, enabling simultaneous margin and scale expansion. For instance, Columbia expects to see >$135mn in cost synergies by Q3'23, a product of branch consolidations, service and contract consolidation, and material reductions in labour expenses.

Beyond the stated cost synergies, the merger with Umpqua supports Columbia's long-run resiliency strategy, increasing the portfolio diversity of the firm. Among Columbia's commercial and industrial portfolio, no industry makes up more than 9.8% of lending. And although office real estate remains a riskier proposition, due to macro impacts (i.e. work from home), the company remains diversified, with strength particular in multifamily products, an asset category with expected double-digit CAGR.

Additionally, the bank remains dedicated to cultivating high-quality, returns generating assets, focusing on well-insured consumer and commercial deposits, proving intrinsic ability to sidestep financial crisis risk.

Wall Street Consensus

Analysts largely support my positive view on the stock, estimating a one-year average price increase of 23.47% to a price of $27.25.

Even at the minimum predicted price of $21.50- a -2.58% decline- investor's return, when incorporating dividends, will essentially be positive. Even then, minimum expectations are a reflection of anxieties regarding asset safety and bank contagion, risks which have largely blown over.

Risks & Challenges

Continued Rate Volatility

As the chart below demonstrates, shifts in interest rates will have long-run effects on the company's ability to generate interest-based income. For instance, if rates decline by 1%, Columbia expects interest income to decline by 3.4%. Although this would not be an existential threat to the business, it would harm the firm's ability to generate adequate cash flows and return value to shareholders.

Bank Crisis Contagion

Though Columbia has avoided the worst of the various bank collapses following Silicon Valley Bank and First Republic Bank, the extraneous risk of adjacent banks failing may lead to an existential liquidity risks for Columbia and are core to the preservation of the business.

Conclusion

In the short term, I expect the market to correct its overreaction to Columbia's exposure to previous bank crises and a subsequent reversion in share price action.

In the long term, I project that Columbia's high-quality assets and its merger with Umpqua will realize material, synergistic growth.

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