FULT - Fulton Financial: Positive Earnings Outlook Attractive Valuation And Manageable Risk

2023-04-10 01:04:58 ET

Summary

• Due to the deterioration of the deposit and loan mixes, the margin’s rate sensitivity will be lower this year relative to last year.
• Economic factors are currently presenting a mixed outlook for loan growth.
• The risk level appears low to moderate. The unrealized losses are at a manageable level.
• The year-end target price suggests a very high upside from the current market price. Further, FULT is offering an attractive dividend yield.

Earnings of Fulton Financial Corporation ( FULT ) will likely continue to grow this year on the back of subdued loan growth and slight margin expansion. I'm expecting the company to report earnings of $1.75 per share for 2023, up 5% year-over-year. Compared to my last report on the company, I've slightly reduced my earnings estimate. The market appears to have overreacted to the rise in Fulton Financial's riskiness amid the banking sector panic. As a result, the stock is trading at a significant discount to its target price. Considering the total expected return, I'm maintaining a buy rating on Fulton Financial Corporation.

Margin Growth to Further Slow Down

Fulton Financial's net interest margin expanded by 15 basis points in the fourth quarter of 2022, which was quite low compared to the third quarter's performance but still better than my expectations. The rate of margin expansion is likely to slow down even further because of a deterioration of the deposit mix during the fourth quarter. Non-interest-bearing deposits dipped to 33.9% of total deposits by the end of December from 34.5% at the end of September 2022. The full-quarter impact of this deterioration will be visible in the first quarter's results.

The loan mix also worsened over the course of 2022. Adjustable and floating rate loans made up 66.9% of total loans at the end of 2022 down from 69.3% at the end of 2021, according to details given in the 10-K filing . (These details are not provided quarterly in the 10-Q filing).

The results of the management's rate sensitivity analysis given in the 10-K filing show that a 200-basis points hike in rates could increase the net interest income by 4.6%.

Considering these factors, I'm expecting the margin to grow by just 5 basis points in 2023. In comparison, the margin rose by 92 basis points from period-end 2021 to period-end 2022.

Expecting Loan Growth to Be Below the Historical Average

Fulton Financial's loan portfolio grew by 3.0% during the fourth quarter of 2022, which was slightly higher than my previous expectations. I'm expecting loan growth to significantly slow down in 2023 due to the high-rate environment. Further, Fulton consolidated some branches for which it incurred expenses of $800,000 in the fourth quarter, as mentioned in the conference call . This measure might also hurt loan originations in the future.

Fulton Financial operates in Pennsylvania, Delaware, Maryland, New Jersey, and Virginia; therefore, its loan book is quite diverse geographically. By loan classes, as well, the loan portfolio is quite diverse, as shown below.

Due to the high geographical diversity, it is appropriate to take national averages when trying to gauge credit demand. As shown below, the services PMI index is still in expansionary territory (above 50) which bodes well for commercial loan growth, while the manufacturing PMI index bodes ill.

Further, while Philly Fed's coincident index gives me hope for loan growth, the OECD leading index dims that hope.

Due to the above metrics, my outlook on loan growth is mixed. Overall, I'm expecting the loan portfolio to grow by 4% in 2023, which is below the CAGR of 5% for the last five years. I'm expecting other balance sheet items to grow in line with loans. The following table shows my balance sheet estimates.

In my last report on Fulton Financial, I estimated earnings of $1.88 per share for 2023. Following the fourth quarter's results, I have tweaked most line items but have not made any big changes. These small tweaks combine to give a material variance between my updated earnings estimate and the previous estimate.

Market Seems to Have Overreacted to FULT's Riskiness

Fulton Financial's stock price has plunged by 17% since March 8, 2023, when the panic in the banking sector started due to recent bank failures. In my opinion, the market has overreacted in Fulton's case because the company's unrealized mark-to-market losses on its available-for-sale ("AFS") securities portfolio totaled $346 million at the end of 2022, which is 14% of total equity. Worse comes to worst and Fulton is forced to sell its securities portfolio, then the unrealized losses will turn into realized losses and erode the company's fair value by ~14%. A market price correction of 17% shows that the market has incorporated more than the worst-case scenario of a 14% dip.

Further, Fulton does not have material exposure to risky or speculative areas, like cryptocurrencies, digital tokens, or start-ups.

The only cause for concern is the large balance of uninsured deposits. According to details given in the 10-K filing, uninsured deposits made up 34% of total deposits at the end of 2022.

Overall, I believe Fulton Financial's risk level is low to moderate.

Maintaining a Buy Rating

Fulton Financial is offering a high dividend yield of 4.9% at the current quarterly dividend rate of $0.15 per share and an annual special dividend of $0.06 per share. The earnings and dividend estimates suggest a payout ratio of 38% for 2023, which is below the five-year average of 43%. To be on the safe side, I'm not expecting a dividend hike, however, the below-average payout ratio shows that there is room for a hike.

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 1.35x in the past, as shown below.

The stock has traded at an average P/E ratio of around 10.8x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $17.7 , which implies a 30.9% upside from the current market price. Adding the forward dividend yield gives a total expected return of 35.8%. Considering the total expected return and the low-to-moderate risk level, I'm maintaining a buy rating on Fulton Financial.

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