HBNC - Horizon Bancorp: Negative Earnings Outlook Doesn't Dampen The Appeal Of A 6% Dividend Yield

2023-11-07 16:23:46 ET

Summary

• Robust pipelines bode well for loan growth in the near term. However, the regional unemployment trend signals a slowdown.
• The declining margin trend is likely to turn around because the up-rate cycle has likely ended. Further, new loan production will help the margin.
• HBNC is currently offering a dividend yield of 6.1%. The dividend appears secure as my estimated payout ratio is only slightly above management’s guidance.
• The year-end target price suggests a high upside from the current market price.

Earnings of Horizon Bancorp, Inc. (HBNC) will most probably dip in upcoming quarters because expense growth will undermine the effect of loan and margin growth. Overall, I’m expecting the company to report earnings of $1.57 per share for 2023 and $1.36 per share for 2024. Next year’s target price suggests a high upside from the current market price. Further, Horizon is offering a high dividend yield of 6.1%. Therefore, I’m maintaining a buy rating on Horizon Bancorp.

Pipeline Bodes Well for Loan Growth but Risks are Emanating from the Regional Economies

Horizon Bancorp’s loan portfolio grew by a strong 2.2% during the third quarter, taking the first nine-month growth rate to 4.9%, or 6.5% annualized. Management mentioned in the earnings presentation that the impressive loan growth was attributable to strong commercial lending performance. This growth momentum is likely to continue in the fourth quarter of the year because of robust pipelines. As mentioned in the presentation, the commercial pipeline stood at $145 million at the end of September 2023 as opposed to $118 million at the end of June 2023.

However, the current regional economic factors present a less rosy picture for loan growth. Horizon Bancorp operates mostly in Michigan and Indiana. The unemployment rates of both states have been trending upward since the middle of this year. This trend indicates a slowdown in regional economic activity, which is bad for loan growth.

Overall, I believe that loan growth should slow down to 1% (4% annualized) every quarter till the end of 2024. The following table shows my balance sheet estimates.

Compared to my last report on the company, which was issued before the second quarter results, I haven’t changed my earnings estimate much because the earnings releases so far have been mostly in line with my expectations. This is the first time I’m giving estimates for 2024.

Risks are Low

Horizon Bancorp’s risk level appears subdued, as discussed below.

1. As mentioned in the presentation, uninsured deposits make up less than 20% of the total deposit book, which seems manageable.
2. Net unrealized losses on the available-for-sale securities portfolio amounted to $2.83 per common share at the end of September 2023, as mentioned in the earnings release . In my opinion, this value isn’t problematic. I’m expecting most of these unrealized losses to reverse in the second half of 2024 when interest rates start declining.

Horizon Offers an Attractive Dividend Yield of 6.1%

Horizon Bancorp is offering a dividend yield of 6.1% at the current quarterly dividend rate of $0.16 per share. The earnings and dividend estimates suggest a payout ratio of 47% for 2024, which is above the five-year average of 29%.

Management mentioned on the conference call, “We expect to continue our targeted dividend payout ratio of 30% to 40%, continuing our 30-year -- plus year of uninterrupted quarterly cash dividends.” Although my estimated payout ratio is higher, I’m not worried because it’s only slightly higher than management’s guidance. I think it’s highly unlikely that management will cut its dividend for a margin so small.

Maintaining a Buy Rating

I'm using the peer average price-to-tangible book ("P/TB") and price-to-earnings ("P/E") multiples to value Horizon Bancorp. Peers are trading at an average P/TB ratio of 1.16 and an average P/E ratio of 8.4, as shown below.

Multiplying the average P/E multiple with the forecast earnings per share of $1.36 gives a target price of $11.40 for the end of 2024. This price target implies a 9.3% upside from the November 6 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $12.90 , which implies a 23.4% upside from the current market price. Adding the forward dividend yield gives a total expected return of 29.5%.

In my last report, I gave a target price of $13.10 per share for the end of 2023, which is quite close to my new target price for the end of 2024. The market price has increased since my last report was issued. Nevertheless, there is still plenty of expected upside left. The dividend yield is also very attractive. Therefore, I’ve decided to maintain a buy rating on Horizon Bancorp.

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