FULT - Fulton Financial: Acquisition Benefits Organic Growth To Lift Earnings

• The recent acquisition of Prudential Bancorp will boost the loan book size and lead to material cost savings.
• Robust commercial loan pipelines and team expansion plans bode well for organic loan growth.
• The rising interest-rate environment will lift the margin but at the same time reduce the equity book value per share, which will hurt valuation.
• The December 2022 target price suggests a significant upside from the current market price. Further, FULT is offering a high dividend yield for a bank holding company.

The recent acquisition of Prudential Bancorp will boost the earnings of Fulton Financial Corporation ( FULT ) through the end of 2023. Further, earnings will benefit from continued organic loan growth. On the other hand, higher provisioning expenses will likely drag earnings. Overall, I'm expecting Fulton Financial to report earnings of around $1.68 per share for 2022, up 3% year-over-year. For 2023, I'm expecting the company to report earnings of $1.79 per share. The year-end target price suggests a high upside from the current market price. Therefore, I'm upgrading Fulton Financial to a buy rating.

Acquisition to be an Important Catalyst for Earnings Through 2023

Fulton Financial completed the acquisition of Prudential Bancorp on July 1, 2022, as recently announced . The acquisition expanded Fulton's presence in Pennsylvania, according to details given in the merger presentation . Further, the acquisition added loans totaling around $594 million, resulting in a 3% boost to Fulton's loan portfolio.

However, the biggest benefit from the acquisition will be the cost savings. The management expects to save 45% of Prudential's operating expenses following the merger, with around 80% phased in this year and 100% thereafter.

On the other hand, the acquisition will likely lower the net interest margin. As mentioned in the presentation, Prudential had a margin of 2.32% in the fourth quarter of 2021, which was much below Fulton's margin of 2.77%. Further, the acquisition will have a dilution effect as Fulton has issued around 6 million shares to Prudential Bancorp’s shareholders.

Outlook on Organic Loan Growth is also Bright

The loan portfolio surged by 2.4% in the second quarter of 2022, or 9.7% annualized, which is the highest quarterly loan growth since the second quarter of 2020. The management appeared optimistic about commercial loan growth in the latest conference call . According to the management, the pipelines have remained strong, which will support growth in the segment in the near term. Further, the management intends to expand the commercial loan team.

Moreover, line utilization is likely to improve, which will boost the outstanding loan balances. As mentioned in the conference call, the management is foreseeing the excess liquidity of businesses to dry up, which it believes will lower deposits but also improve the line of credit utilization.

However, the outlook for consumer loan growth is not that bright. Higher interest rates are likely to hurt this segment the most as individual borrowers will likely put off borrowing until a time when rates are lower. The Federal Reserve projects rates to start declining from next year.

Overall, I'm expecting the loan portfolio to grow by 9.5% in 2022. Loan growth will likely return to the usual mid-single-digit range for 2023 in the absence of another M&A transaction.

Meanwhile, the rising interest-rate environment will compress equity book value per share. This is because higher rates will reduce the value of fixed-rate securities, thereby increasing the accumulated unrealized loss on securities, which will flow directly to the equity account bypassing the income statement. The following table shows my balance sheet estimates.

Compared to my last report on Fulton financial, I've significantly increased my earnings estimate for 2022. This is because Fulton has announced the acquisition of Prudential Bancorp since the issuance of that last report. Further, the economic outlook has changed significantly since that report.

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.

Upgrading to a Buy Rating

Given the earnings outlook, I’m expecting Fulton Financial to increase its dividend per share by $0.01 in the first quarter of 2023 to $0.16. Fulton Financial also usually announces a special dividend in the last quarter of the year, which I’m expecting to be maintained at $0.08 per share. My dividend and earnings estimates suggest a payout ratio of 40% for 2023, which is close to the last four-year average of 44%. Therefore, I believe my expectation is reasonable. The dividend estimate for 2022 suggests a dividend yield of 4.2% and the estimate for 2023 suggests a dividend yield of 4.4% (including the special dividend).

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Fulton Financial. The stock has traded at an average P/TB ratio of 1.42 in the past, as shown below.

The stock has traded at an average P/E ratio of around 12.0x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $17.9 , which implies a 9.6% upside from the current market price. Adding the dividend yield gives a total expected return of 13.8%.

In my last report, I adopted a target price of $17.7 on Fulton Financial. At the time of the issuance of that report, the market price was slightly higher than the target price; therefore, I adopted a hold rating. Since then, the market price has plunged, leaving a decent upside to the year-end target price. Therefore, I'm now upgrading Fulton Financial Corporation to a buy rating.

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