CBSH - Commerce Bancshares: Topline Outlook Is Rosy But Stock Appears Overvalued

• Loan growth will decelerate due to high interest rates and falling consumer confidence. Nevertheless, it will remain near the historical average thanks to commercial loans.
• The top line is only moderately sensitive to rate changes.
• Higher interest rates will continue to drag the equity book value per share, which will hurt equity valuation.
• The December 2022 target price suggests a significant downside from the current market price. Further, CBSH is offering a low dividend yield.

Moderate loan growth that's in line with the historical average will likely support the earnings of Commerce Bancshares, Inc. (CBSH) through the end of 2023. Further, the moderately rate-sensitive topline will benefit from higher interest rates. On the other hand, higher net provision expense will drag earnings. Overall, I'm expecting Commerce Bancshares to report earnings of $3.97 per share for 2022, down 8% year-over-year. Compared to my last report on the company, I've tweaked upwards my earnings estimate mostly because I've increased both my loan growth and margin estimates. The year-end target price suggests a significant downside from the current market price. Based on the total expected return, I'm adopting a hold rating on Commerce Bancshares.

Loan Growth To Decelerate

Commerce Bancshares loan growth continued to beat my expectations in the second quarter of 2022. The portfolio grew by 1.5% in the second quarter of 2022, bringing the first half growth to 3.5% (7% annualized).

Around 63% of the loan portfolio is made up of commercial loans, as mentioned in the earnings presentation . Therefore, the purchasing managers’ index is a good gauge for product demand. Although the index has recently been on a downtrend, it is still in expansionary territory (above 50), which bodes well for loan growth.

For consumer loans, the outlook is less bright. The consumer confidence index has continued to drop so far this year. Moreover, due to high interest rates, consumers wanting to borrow for less pressing expenditures will prefer to wait until borrowing costs decline.

Considering these factors, I'm expecting loan growth to return to the historical norm of the mid-single-digit range for the second half of 2022 and the full year of 2023. In my last report , I anticipated loan growth of 5.1% for 2022. I have now decided to tweak it upwards to 5.6% mostly because of the second quarter’s performance.

Book Value Has Taken A Hit from Higher Interest Rates

The surge in interest rates so far this year has eroded Commerce Bancshares’ equity book value. This is because increase in rates decreased the value of fixed-rate investment securities. This unrealized loss flowed directly into equity bypassing the income statement. By the end of June 2022, the book value per share had declined by $2.31 from the end of March 2022 and $6.18 from the end of June 2021, as mentioned in the earnings presentation.

Going forward, further equity book value erosion is on the cards as I'm expecting the federal funds rate to increase by a further 75 basis points in the remainder of the year, before plateauing and then trending downwards in the second half of 2023. The following table shows my balance sheet estimates.

In my last report on Commerce Bancshares, I estimated earnings of $3.82 per share for 2022. I've revised upwards my earnings estimate because I've tweaked upwards both my loan growth and margin estimates.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.

Current Market Price is Above the Target Price

Commerce Bancshares is offering a dividend yield of 1.5% at the current quarterly dividend rate of $0.265 per share. The earnings and dividend estimates suggest a payout ratio of 25% for 2023, which is close to the five-year average of 30%. Although there is room for a dividend hike, I’ve incorporated no change in the dividend for my investment thesis to remain on the safe side. Commerce Bancshares also usually gives a 5% stock dividend in the fourth quarter of the year.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Commerce Bancshares. The stock has traded at an average P/TB ratio of 2.28 in the past, as shown below.

The stock has traded at an average P/E ratio of around 16.6x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $58.4 , which implies a 19.0% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 17.5%.

Considering the cash and stock dividends and the price downside, I'm adopting a hold rating on Commerce Bancshares.

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