PEBO - Peoples Bancorp: Dividend Yield Looks Interesting But Maybe There Is A Better Alternative

2023-11-10 15:22:01 ET

Summary

• Peoples Bancorp's stock price has remained stable in 2023, with a dividend yield exceeding 5%.
• The bank's deposits are sound and low cost compared to peers.
• The bank's profits are growing, and its nonperforming loans are improving, two good signs of dividend sustainability.

Peoples Bancorp ( PEBO ) operates as a holding company for Peoples Bank, which provides commercial and retail banking products and services. It was founded way back in 1902 and is headquartered in Marietta, Ohio.

Unlike many peers that have performed terribly in 2023, Peoples Bancorp's stock price has pretty much remained stable, except for the post-bankruptcy period of SVB. In any case, the dividend yield today has exceeded 5% and this is drawing the attention of dividend investors.

In this article, I will express my opinion on whether it is worth investing in this bank for its dividend yield.

Sustainability of the dividend

Before even considering growth, it is crucial to understand whether the dividend is sustainable or not.

As we can see, this bank tends to issue an increasing or at least stable dividend, however, in the event of a recession there is a risk that the dividend cut could eat up the increase of previous years. This happened in 2009 but not in 2020.

Certainly, recessions such as the subprime crisis are not commonplace, but for those who have a long-term view and expect to get a significant yield on cost in 10 to 15 years, this is a factor to consider.

The current payout ratio is about 45% , higher than the industry median of 36%, but nothing worrisome enough to assume a dividend cut. In any case, this ratio also marked the same result in 2007, so it is useful only for short-term forecasting. We can be somewhat certain that, for the next quarter, the dividend will be sustainable, but a year from now the situation may change.

In banking, things change very quickly and it is complex to make predictions. However, in the case of Peoples Bancorp, the stability of its deposits may help us make more forward-looking forecasts.

Indeed, unlike peers, this bank has managed to keep its non-interest bearing deposits almost unchanged and has a relatively low cost of total deposits.

Compared to the pre-bankruptcy period of SVB, non-interest-bearing deposits have only dropped by 1.20%, despite all the difficulties incurred in 2023. In addition, total deposits have increased by 23% and the average cost of liabilities is 1.96%, thus not too high compared to current money market rates.

In addition to a relatively low cost of funds, there is a rather high yield on loans, 7.20% on average in Q3 2023 . Consequently, benefiting from this is the net interest margin, now at 4.70% and up 16 basis points from the previous quarter and 53 basis points from the previous year. Peers with similar market capitalization - from $500 million to $999 million - have an average net interest margin of 3.25% , much lower than Peoples Bancorp's.

Profit for Q3 2023 was $31.90 million, up $10.20 million from the previous quarter and up $5.90 million from last year. In other words, Peoples Bancorp's results appear to be in contrast to those of peers, where many of them have not yet reached the bottom of the net interest margin.

So, growing profits and expanding margins are two factors that imply dividend sustainability, at least as long as this trend continues. Finally, it is worth noting that a major change in interest rates could change the situation.

Peoples Bancorp is positioned for further increases, so if the Fed makes a surprising decision to reduce the Fed Funds Rate, both net interest income and equity would be negatively impacted.

A collapse of 300 basis points in the coming months is definitely unlikely, but in the event of a recession in 2024, I would not rule out a reduction of 100 basis points at least. Anyway, at least for now, we are not facing a new 2008, so even if there is a recession, my view is that it will not have the same impact on banks.

Nonperforming loans are stable, accounting for only 0.58% of total loans. Incidentally, this figure is an improvement over last year, where they were 0.79%.

Overall, for the current dividend to no longer be sustainable, a severe recession would have to occur, which would again cause rates to fall quickly. In my opinion, this is unlikely now, and even if it were, banks are better positioned than in 2008 where they were lending money to anyone. At least for now, the payout ratio of about 45% seems sufficient to ensure the sustainability of the dividend for the next few years.

Dividend growth

Dividend growth depends mainly on Peoples Bancorp's earnings growth.

According to Street Estimates, future growth does not look great, probably because it discounts an economic slowdown. Typically, when interest rates are this high they inhibit economic growth and consequently bank growth.

Over the past 10 years, annual EPS growth (GAAP) has been 7.80%, far higher than that expected through 2025. After all, the reason for this divergence is quite obvious: there has been an unprecedented expansionary monetary policy in recent years, and this has encouraged economic growth.

At the same time, the annual growth rate of dividends over the past 10 years has been 11.12%, also aided by the macroeconomic environment during that period. Realistically, I believe that for the next 10 years the dividend growth rate will be far lower, and in fact we are already observing this since in the last three years the CAGR has dropped to 4.20% .

Based on Street Estimates for EPS and the 3-year dividend CAGR, in 2025 the dividend per share is expected to be $1.69, with a payout ratio of 44%. By buying Peoples Bancorp today, the yield on cost at the end of 2025 would be about 6%. In short, a great and solid dividend yield.

However, there is one aspect to think about that might make this dividend less inviting. Is it worth it today to get a dividend yield of 5.40% - potentially 6% in 2025 - when the Treasury Bond yield is just under 5%?

Earning a few percentage points per year more than a risk-free rate may not prove to be such an attractive investment. Moreover, considering the TLT ( TLT ) ETF, since it has collapsed like never before, there is good potential for substantial capital gains in the future as well.

In short, if we were to compare Peoples Bancorp's dividend yield to the U.S. government bond yield, I would prefer the latter since the risk/return ratio is better. This is probably why companies that issue high dividends are currently under-appreciated by the market.

Conclusion

Peoples Bancorp is a bank that has performed quite well compared to the banking industry, mainly because its profitability has continued to improve. Deposits are affordable, and loan yields have increased a lot but without raising concerns about nonperforming loans.

Since its dividend yield is quite high relative to historical values it would seem that this is a good time to invest in Peoples Bancorp, but watch out for alternatives. Treasury yields are just below the dividend yield and are risk-free, which is why I personally believe it makes more sense to invest in the former. For those who believe there is the potential for significant capital gain by investing in Peoples Bancorp the argument changes, but I personally do not hold that view. The rate hikes have not yet been fully discounted by the economy, and this could bring the banking sector into trouble again. In contrast, bonds perform well during difficult times.

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