BPOP - Popular: Attractively Valued But Earnings Likely To Dip

• The management's new investment plans and economic strength in Puerto Rico will drive loan growth through 2023.
• Management's investment plans and inflationary pressure on salaries will likely lift non-interest expenses.
• Provisioning will likely get closer to the historical average due to heightened interest rates.
• The December 2022 target price suggests a significant upside from the current market price. Further, BPOP is offering a modest dividend yield.

Earnings of Popular, Inc. ( BPOP ) will most probably dip this year relative to last year on the back of higher provisioning and operating expenses. On the other hand, decent loan growth and some margin expansion will support the bottom line. Overall, I'm expecting Popular to report earnings of $10.61 per share for 2022, down 7% year-over-year. Compared to my last report on the company, I’ve barely changed my earnings estimate as the upward revision in loan growth estimate cancels out the upward revision in expense estimates. The year-end target price suggests a high upside from the current market price. Therefore, I'm maintaining a buy rating on Popular.

Investment Plans to Act as a Catalyst for Loan Growth

Popular’s loan portfolio continued to grow strongly through the second quarter of 2022. Loan growth will likely continue to remain robust in the coming quarters, thanks to the management’s plans and efforts. Popular has significantly increased its budget for investments. As mentioned in the conference call , the management is planning additional investments in digital offerings. Further, it is launching other early-stage initiatives to enhance customer experience.

Moreover, Puerto Rico's continued economic strength will support loan growth in the coming quarters. The economic activity index of the Economic Development Bank for Puerto Rico continues to remain strong, which bodes well for loan growth. The index was up 3.3% year-over-year in May 2022.

Moreover, the unemployment rate was down to 6.1% in June 2022, which is an astonishing improvement in a historical context.

Considering these factors, I'm expecting the loan portfolio to grow by 6.6% in 2022. In my last report on Popular, I estimated loan growth of 4.3%. I've revised upwards my loan growth estimate due to the second quarter's performance as well as a better economic outlook.

Deposits will likely not fare as well as loans in the coming quarters. The management mentioned in the conference call that it expects public deposits to drop to $11 billion to $15 billion by the year-end from $17 billion at the end of June 2022. Further, commercial deposits will also decline as companies will chase yields and shift their cash at the bank into treasury securities.

Further, the equity book value will take a hit from rising interest rates. Popular has a large balance of debt securities, which made up almost 40% of total assets at the end of June 2022. The value of these securities will go down as rates rise. Consequently, the equity book value will decline. The tangible book value per share has already dipped from $51.16 at the end of March 2022 to $46.18 at the end of June 2022. As mentioned in the earnings presentation , the dip in equity book value was mainly driven by the $563 million increase in accumulated unrealized losses on fixed-rate debt securities available for sale.

The following table shows my balance sheet estimates.

In my last report, I estimated earnings of $817 million for 2022 while now I'm expecting earnings of $810 million. I've barely changed my earnings estimate because the upward revision in loan growth estimate cancels out the upward revision in the provision and operating expense estimates.

Actual earnings may differ materially from estimates because of the risk of hurricanes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.

High Price Upside Calls for a Buy Rating

Popular is offering a dividend yield of 2.9% at the current quarterly dividend rate of $0.55 per share. The earnings and dividend estimates suggest a payout ratio of 21% for 2022, which is close to the last four-year average of 19%. Therefore, the dividend appears secure despite the earnings outlook.

I’m using the peer-average price-to-book (“P/B”) and price-to-earnings (“P/E”) multiples to value Popular. Peers are currently trading at an average P/B ratio of 1.33x, and an average P/E ratio of 9.86x, as shown below.

Multiplying the average P/E multiple with the forecast earnings per share of $10.61 gives a target price of $104.6 for the end of 2022. This price target implies a 35.9% upside from the August 3 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 $92.2 , which implies a 19.8% upside from the current market price. Adding the forward dividend yield gives a total expected return of 22.6%. Hence, I’m maintaining a buy rating on Popular. However, Popular is not suitable for low-risk-tolerant investors ahead of the hurricane season. Due to its location, the company is highly vulnerable to natural disasters.

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