CA - Laurentian Bank: Discounted Canadian Bank Putting Itself Up For Sale

2023-07-25 01:14:27 ET

Summary

• Laurentian Bank of Canada, the country's ninth-largest lender, is reportedly up for sale.
• The bank primarily operates as a retail lender in Quebec and a commercial lender in Quebec, Ontario, Alberta, British Columbia, and Nova Scotia.
• Using comparable transactions and peer valuations, there is a 10-50% upside to Laurentian shares if a sale is consummated.

Recently, I came across a Globe And Mail news article that Laurentian Bank of Canada ( LB:CA ) (LRCDF), the 9th largest lender in Canada, is putting itself up for sale .

Laurentian Bank is a small commercial and personal lender, primarily focused on Quebec. I believe Laurentian may appeal to some of its bigger peers who want to expand their presence in Quebec. Using comparable transactions and peer valuations, I believe there is 10-50% upside to Laurentian shares if a deal is consummated. I rate Laurentian a speculative buy.

(Author's note, all financial figures in this article is in Canadian dollars)

Company Overview

Laurentian Bank of Canada is a Schedule 1 bank that operates primarily in the province of Quebec, Ontario, Alberta, British Columbia, and Nova Scotia (Figure 1).

The bank primarily operates in 3 main segments: Commercial Banking, Personal Banking, and Capital Markets.

Personal Banking

Laurentian Bank is an omni-channel bank for 460,000 customers, mostly in the province of Quebec with its network of 57 branches. Laurentian offers the full gamut of retail banking products for its customers including credit cards, residential mortgages and deposits.

Commercial Banking

Commercial Banking is the core business of Laurentian and has been the bank's main growth driver in the past few years. Laurentian is known for commercial real estate financing, commercial loans to small and medium sized enterprises ("SME"), equipment financing, and inventory financing (Figure 2).

Laurentian also has a sizeable U.S. presence in equipment and inventory financing that contributes about a quarter of the bank's loan book.

Capital Markets

Within Capital Markets, Laurentian Securities is a small broker/dealer focused primarily on niche verticals that align with the bank's commercial focus. Laurentian notably restructured its capital markets business in the last few years by exiting its sub-scale research and advisory business on the Canadian oil and gas sector, and focusing instead on the budding green and social bond market.

Financial Review

Financially, Laurentian is a minnow compared to its Canadian peers, with only $51 billion in assets as of April 30, 2023, while the big 6 banks like TD and RBC are well past $1 trillion in assets.

Laurentian Is A Sub-Scale Inefficient Lender...

Laurentian appears to be under-earning compared to its peers, with return on equity ("ROE") of 7.6% in the 6 months to April 30, 2023. The big 5 Canadian banks earned on average ROE of 11.7% in the trailing 12 months compared to Laurentian's 7.7% (Figure 5).

The main culprit for Laurentian's poor profitability is its small scale, which leads to the bank recording an efficiency ratio (non-interest expense relative to revenues) of ~70% compared to peers who on have efficiency ratios in the low 60s.

...Leading To Discounted Valuation

Laurentian's poor profitability has hindered the bank's valuation, with the bank consistently trading at a discount to peers (Figure 6).

In fact, prior to the latest news article mentioned above, the bank's shares were trading sub $35 / share, or roughly 0.6x its most recent book value of $59.06 / share.

In The Midst Of A Turnaround Plan

To address its perennially poor financial performance, Laurentian bank launched a restructuring / turnaround plan in 2020 by firing its prior CEO (who was incidentally given a mandate to modernize the bank as well) and hiring its current CEO, Rania Llewellyn, from the Bank of Nova Scotia. Ms. Llewellyn's medium-term turnaround plan is to transform Laurentian into a bank that can grow earnings at a high-single-digit ("HSD") rate while delivering over 10% ROE to shareholders (Figure 7).

However, judging by Laurentian's deteriorating performance in fiscal 2023 compared to 2022 (figure 4 above), with YTD ROE of 7.6% vs. 9.2% YoY, Ms. Llewellyn's plans have yet to bear fruit.

Another Round Of Consolidation In A Consolidated Market?

At the same time, there appears to be yet another round of consolidation in the already heavily consolidated Canadian banking market, with Royal Bank of Canada ("RBC") agreeing to acquire HSBC's Canadian operations for $13.5 billion in November 2022.

HSBC's pending sale to RBC likely prompted Laurentian's board of directors to reconsider the feasibility of their turnaround strategy and whether there are better ways to surface value for shareholders. According to the Globe and Mail article, Laurentian Bank confirmed it is 'conducting a review of strategic options' after the news article came out.

What Can A Sale Fetch?

Using the RBC/HSBC Canada transaction as a guide, we can see that RBC agreed to pay $13.5 billion or 9.4x HSBC Canada's 2024 earnings, inclusive of synergies. Before synergies, the price tag works out to 14.5x 2024 P/E ($13.5 billion divided by $932 million in net income after tax) (Figure 8).

Obviously, the price an acquirer is willing to pay for Laurentian will be dependent on how much synergies the acquirer can squeeze out of the assets (i.e. layoffs and branch closures). If I apply 14.5x to Laurentian's LTM EPS of $4.64, I get $67.28 / share in value.

However, 14.5x may be aggressive, as the big 5 banks are only trading at an average Fwd P/E multiple of 12.2x themselves (Figure 9). If we use 12.2x instead, applied to Laurentian's LTM EPS of $4.64 (Seeking Alpha does not have consensus estimates for Laurentian Bank), we get $56.60 / share.

Finally, with Laurentian trading at a steep discount to its book value, I believe an acquirer may be willing to pay 0.8x to 1.0x P/B or $47.25 to $59.09 per share for Laurentian.

Compared to Laurentian's current trading price of ~$43 / share, there appears there is significant upside (10-50%) if a sale were to be consummated.

Risks To Laurentian Shares

The biggest risk to Laurentian's stock is if the strategic review were to conclude without a transaction, then Laurentian's stock price may fall back to pre-rumour valuations (sub-$35) or worse, since every other potential suitor would have been invited into Laurentian's data room by now.

As a standalone bank, it is unclear whether Laurentian's turnaround strategy will ultimately bear fruit, especially as the Canadian economy is weakening from high inflation and repeated interest rate increases.

Another risk is that any proposed deal may not receive ultimate regulatory approval. As I noted previously, the Canadian banking sector is already heavily consolidated and mergers are highly scrutinized by the banking regulators. Already, we are seeing the RBC/HSBC Canada deal getting delayed due to regulatory concerns about competition.

Conclusion

With Laurentian Bank putting a 'for sale' sign on its front-lawn, I believe its shares may be worth a speculative buy for investors with a high risk tolerance. Using comparable transactions and peer valuations, I believe there is 10-50% upside if Laurentian is able to find a suitor. On the other hand, if no deal is announced from the strategic review, Laurentian's shares may see ~20% downside back to their pre-rumour price.

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