BPOP - Popular: High Price Upside But Risks Are Also High

2023-04-19 20:56:32 ET

Summary

• Last year's rapid economic improvement in Puerto Rico seems to have taken a breather in the last few months. Therefore, I've decided to reduce my loan growth estimate.
• The December 2023 target price suggests a high upside from the current market price. Further, BPOP is offering a decent dividend yield.
• The risk level is above average for BPOP because of natural disasters and large unrealized losses on the available-for-sale securities portfolio.

Earnings of Popular, Inc. ( BPOP ) will most probably dip this year as loan growth will be unable to compensate for the inflation-driven hike in operating expenses. I'm expecting the company to report earnings of $2.32 per share for the first quarter of 2023, and $9.59 per share for the full year. Compared to my last report on the company, I've reduced my earnings estimate mostly because I've decreased both my loan growth and margin estimates. I'm adopting a buy rating on BPOP stock because it is trading at a large discount to its target price. However, Popular Inc. has above-average risk; therefore, I believe it's not suitable for all types of investors.

Loan Growth to Move Closer to the Historical Average

After a phenomenal year, loan growth will most probably slow down in 2023. Apart from the high-interest rate environment, an economic slowdown will contribute to a decline in loan growth this year. Puerto Rico's economic activity has been declining, on a year-over-year basis, since September last year.

The territory’s unemployment rate is currently near record lows. The IMF projects it to rise to 9% over the next two years, as shown in the chart below. However, even after a rebound, the rate will be lower than the average for the past decade.

In my last report on Popular Inc., I estimated loan growth of 8% for 2023. Since the issuance of that report, the economic activity index has persistently declined y-o-y with every reading. Therefore, I've decided to reduce my loan growth estimate. I'm now expecting the loan portfolio to grow by 6% this year. The following table shows my balance sheet estimates.

Natural Disasters Remain the Biggest Source of Risk

Due to the following two factors, I believe Popular Inc.’s risk level is above average.

1. The biggest risk factor for Popular, Inc. is natural disasters as Puerto Rico is susceptible to hurricanes. Fortunately, hurricane seasons since 2017 have not been too destructive.
2. Gross unrealized losses on the available-for-sale securities portfolio totaled $1,759.7 million at the end of December 2022, as mentioned in the 10-K Filing. These losses are as large as around 43% of total equity and 1.6 times the net income for 2022. Therefore, the earnings at risk are quite high. However, it's highly unlikely that these unrealized losses will turn into realized losses. Firstly, it’s because these losses are due to interest rate changes and not due to impairment. Most of the investment securities are treasury and agency mortgage-backed securities which carry minimal risk. Secondly, it's very unlikely that there will be a bank run in Puerto Rico that could force Popular to sell its securities at a loss. It's business as usual in the territory with no signs of panic.

Maintaining a Buy Rating Due to a High Total Expected Return

Popular, Inc. is offering a dividend yield of 3.8% at the current quarterly dividend rate of $0.55 per share. The earnings and dividend estimates suggest a payout ratio of 23% for 2023, which is close to the five-year average of 18%. Therefore, I’m not expecting a dividend hike in the year ahead.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Popular, Inc. The stock has traded at an average P/TB ratio of 1.163x in the past, as shown below.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $45.2 gives a target price of $52.6 for the end of 2023. This price target implies a 9.4% downside from the April 18 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $69.9 , which implies a 20.5% upside from the current market price. Adding the forward dividend yield gives a total expected return of 24.3%. Hence, I’m maintaining a buy rating on Popular, Inc. However, this stock has above-average risk; therefore, it’s not suitable for low-risk-tolerant investors.

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