CBU - Community Bank's Earnings Will Likely Grow Next Year But Stock Appears Overvalued

• Healthy pipelines, investments in talent, and strong job markets will likely support loan growth in the coming quarters.
• Provisioning will likely be above normal in the second half of 2022 as the existing allowance level appears somewhat lacking ahead of a possible recession and heightened interest rates.
• The December 2022 target price suggests a significant downside from the current market price. Further, CBU is offering a low dividend yield.

Earnings of Community Bank System, Inc. (CBU) will most probably dip this year on the back of higher provisioning for expected loan losses. On the other hand, moderate loan growth on the back of healthy pipelines and investments in human resources will likely support the bottom line. Overall, I'm expecting Community Bank System to report earnings of $3.35 per share for 2022, down 3.7% year-over-year. For 2023, I'm expecting the company to report earnings of around $3.69 per share. The current market price is much higher than the year-ahead target price. Therefore, I'm adopting a sell rating on Community Bank System.

Healthy Pipelines, Investments to Drive Moderate Loan Growth

Community Bank's loan portfolio received a decent boost from the acquisition of Elmira Savings Bank during the second quarter of 2022. The loan book grew by 9.7% in the second quarter, as opposed to a more normal 0.7% in the first quarter of 2022. Loan growth for the third quarter will likely be somewhat better than the first quarter because the commercial loan pipeline is at an all-time high, as mentioned in the latest conference call . Moreover, the management is positive that loan growth will continue thanks to investments in the talent of the commercial and mortgage businesses.

Strong job markets will likely also play a role in supporting loan growth. Community Bank System operates in several northeastern states, namely New York, Pennsylvania, Vermont, and Massachusetts. Three of these states (NY, PA, MA) have worse unemployment rates than the national average, but all four have phenomenal job markets when considered from a historical perspective.

Although mortgage rates have dipped recently, they are still very high from a historical perspective. High interest rates are likely to hurt residential mortgage loan growth as people will try to put off their home purchases until better times. Consumer mortgages make up a hefty 36% of total loans. However, even in past bust markets, Community Bank System has managed to grow its mortgage business by 3% to 4%, as mentioned in the conference call. Therefore, high interest rates won’t eradicate loan growth, just slow it down.

Overall, I'm expecting the loan portfolio to grow by 1.5% in the second half of 2022, leading to full-year loan growth of 12.1%. I'm expecting the loan book to grow at a somewhat higher rate next year compared to the second half of this year, closer to the historical average.

Meanwhile, deposits will likely grow in line with loans through the end of 2023. On the other hand, the tangible book value per share will likely suffer in the third quarter because the hike in interest rates will lower the value of the investment securities held on the books. Community Bank System had a large securities portfolio at the end of June 2022, which made up 36% of total assets. The tangible book value per share has already plunged to $14.69 per share at the end of June 2022 from $23.77 per share at the end of March 2022, as mentioned in the earnings release . The following table shows my balance sheet 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 projection. The new Omicron subvariant also bears monitoring.

CBU Appears Overvalued

Community Bank has increased its dividend in the third quarter of every year since 2011 (the annual increase trend goes back 30 years, but the hike was not scheduled for the third quarter before 2011). If the company increases its dividend by $0.01 per share to $0.45 per share in the third quarter of 2023, then the implied payout ratio next year will be 48%, which is in line with the five-year average. Therefore, the company can easily continue its dividend tradition next year. Based on the current market price and the implied dividend, Community Bank is offering a forward dividend yield of 2.6%.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Community Bank System. The stock has traded at an average P/TB ratio of 3.01x in the past, as shown below.

The stock has traded at an average P/E ratio of around 19.7x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $54.4 , which implies a 19.2% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 16.6%. Hence, I’m adopting a sell rating on Community Bank System.

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