HBNC - Horizon Bancorp: Depressed Valuation Still Doesn't Constitute A Buy

2023-08-22 18:29:50 ET

Summary

• Horizon Bancorp's valuation has decreased by 40% in the past year due to slowing growth and challenges in maintaining deposits.
• The regional bank industry has been negatively impacted, creating pressure on Horizon Bancorp's share price.
• The company operates in the regional banks sector, providing a range of banking services and loans, with a focus on the Michigan and Indiana areas for growth.

Introduction

The valuation of Horizon Bancorp Inc ( HBNC ) has seen a 40% slash over the last 12 months as the growth is slowing down, and the company is fighting to maintain deposits similar to levels a year ago. The depressed valuation might seem like a good entry point right now, but I fear that growth is still a bit out and the company needs to ensure investors that they can hit their projections for 2023.

The regional bank industry was hit quite hard as two of the major companies there saw their business meltdown. As I have discussed in a lot of my articles about financial companies, the ripple effect this had on other companies in the regional bank's industry seems to persist somewhat, creating pressure on the share price. The dividend yield from HBNC is very appealing right now though which makes having a hold rating for the company reasonable and potentially a buy depending on the results for the full year of 2023 and whether or not the company can reach the targets they have set.

Company Structure

As we know HBNC operates in the regional banks sector where it provides a broad range of both commercial and retail banking services. Saving, money market, and time deposits are some of the services they have for clients and customers. Seeing as they are a bank they do also have loans for various purposes and are managing a loan portfolio and leveraging that to generate higher ROE and return capital to investors through dividends. Looking at the type of loans the company offers it covers commercial, residential real estate, and mortgage warehouse loans.

The company covers the Michigan and Indiana areas which it sees as long-term viable for a lot of growth as manufacturing capabilities are increasing and loans are needed to take on to fund that. This gives HBNC a decent market to cater to and one that hopefully would ensure a higher TTM ROE of 11.9% which they have currently. This would add more fuel to the dividend and result in a continuation of the over 11% yearly growth rate in the last couple of years.

With a diversified loan portfolio, the company has ensured some form of stability, but in times of higher interest rates there is often lower activity for banks and right now I think they need to focus on acquiring more depositors, so they can build the bottom line. Nearly 50% of the portfolio is comprised of real estate-related loans, and with the housing market seeing some lower demand I think HBNC is unlikely to post higher loan growth in that segment, at least for the short-term and possibly medium term too.

Valuation & Comparison

Looking at the GGM model above here we can see that the share price isn't necessarily offering that much of an immediate upside potential. A target price of $12.8 is set for 2023 as an estimated dividend per share of $0.64 is used. Even though the company has been growing its dividend by over 11% annually for the last 5 years I think using something more conservative here is useful. If not, the target share price would be well over 100% upside from now, and I honestly don't think the market is mispricing HBNC that much currently. The p/e for example is around 7 and the p/b at 0.74. That isn't a high undervaluation per se and a lot of reasons behind these multiples might be the risks associated with regional banks right now. Some are seemingly too hard to swallow and accept. For me, what holds me to the rating I have is the fact that the company is lacking strong growth currently, even in a high-interest environment, which in most cases would be beneficial to banks, but seemingly not here.

Risk Associated

This marks a consecutive decline in average total deposits for the second quarter, settling at approximately $5.6 billion. Over this span, as the Federal Reserve initiated a swift upswing in interest rates, Horizon Bancorp found itself compelled to elevate the yield on its deposits. This strategic response was pivotal in averting the potential mass departure of its customer base, safeguarding both trust and loyalty. In most cases, a higher interest rate would result in insignificantly higher earnings for a bank, which is why in a lot of cycles with interest rates the share price grows for banks when rates increase. For HBNC it seems the markets and regions they are in are placing challenges where this isn't necessarily possible for them to do.

The challenge at hand is rooted in the expansion in nominal terms rather than the mere percentage shift in costs. Remarkably, the threshold of average total deposits has remained below $5.9 billion for an extended span of approximately two and a half years. This persistent plateau in deposit growth raises pertinent questions about the underlying factors influencing customer behavior and the broader economic landscape. For coming quarters we need to see an increase here for a buy case to be considered.

Despite the consistent nominal figures, it's crucial to delve deeper into the drivers behind this stagnation. Are there specific market trends, consumer preferences, or external economic conditions that are constraining the growth of deposits within this range? Watching the growth of non-performing loans is one way I think to determine whether HBNC is in a good spot or not. It has been climbing ever so slightly over the last few quarters.

Investor Takeaway

The valuation for HBNC may be depressed following turmoil in its industry, but the lacking growth of loans is also playing a part. Until there is clear growth taking shape then I won't be viewing the company as a buy. The company has some targets set for 2023 like total loans growing 6 - 8% YoY which would be great if they achieve it. I am happy to wait on the sidelines though and rate HBNC a hold instead.

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