PB - Prosperity Bancshares: Flattish Earnings Unattractive Valuation

• Higher interest rates will likely drag the value of investment securities, and consequently the equity book value.
• The second quarter's performance will likely be repeated in the year ahead.
• The December 2022 target price suggests a small upside from the current market price. Further, PB is offering a modest dividend yield.

Earnings of Prosperity Bancshares, Inc. (PB) will most probably remain flattish this year relative to last year. Decent loan growth and slight margin expansion will likely drive the top line. On the other hand, an increase in expenses proportional to loan growth will keep earnings flattish. Overall, I'm expecting Prosperity Bancshares to report earnings of $5.64 per share for 2022, up by just 0.6% year-over-year. Compared to my last report on the company, I’ve slightly increased my earnings estimate mostly because I've tweaked upwards my loan growth estimate. The year-end target price suggests a small upside from the current market price. Therefore, I'm maintaining a hold rating on Prosperity Bancshares.

Loan Portfolio’s Good Performance in 2Q Likely to Recur

After seven consecutive quarters of decline, the loan portfolio finally turned around in the second quarter of 2022 and grew by 2.4%. Now that the paycheck protection program forgiveness is almost over, the loan portfolio will likely continue to grow in the coming quarters. As mentioned in the conference call , the management is positive that it can achieve mid-single-digit loan growth for 2022. As historically too loan growth, excluding acquisitions, has remained in the mid-single-digit range, the management's target for 2022 appears reasonable.

Further, Prosperity Bancshares operates in the states of Texas and Oklahoma, where strong job markets bode well for loan growth. While Oklahoma has a remarkably strong job market with an unemployment rate much below the national average, Texas’ labor market isn't that strong. Nevertheless, both states have unemployment rates near multi-decade lows, as shown below.

Overall, I'm expecting the loan portfolio to grow by 3.4% in 2022. In my last report on Prosperity Bancshares, I estimated the loan portfolio to decline by 2.3% this year. I've revised my loan growth estimate due to the second quarter's good performance and an improved outlook.

Rising Interest Rates to Hurt the Securities Portfolio

Rising interest rates will have a negative impact on securities, and consequently equity. Prosperity Bancshares has a big investment securities portfolio, which made up 40% of total assets at the end of June 2022. As most securities carry fixed rates, their value will fall as rates rise. This means the book value per share is set to take a material hit from rising interest rates this year.

Overall, I'm expecting the securities portfolio to grow by 4% and common equity to grow by 2% in the second half of 2022, (earnings and dividend estimates, which also drive the equity balance, are discussed below). The following table shows my balance sheet estimates.

In my last report on Prosperity Bancshares, I estimated earnings of $5.48 per share for 2022. I've revised upwards my earnings estimate mostly because I've increased my loan growth estimate.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.

Current Market Price is Quite Close to the Year Ahead Target Price

Prosperity Bancshares has a long-standing tradition of increasing its dividend in the last quarter of the year. Given the earnings outlook, it’s likely that the company will maintain the dividend trend this year. Therefore, I’m expecting the company to increase its dividend by $0.03 per share to $0.55 per share in the fourth quarter of 2022. The earnings and dividend estimates suggest a payout ratio of 37% for 2022, which is close to the five-year average of 35%. Based on my dividend estimate, Prosperity Bancshares is offering a dividend yield of 2.9%.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Prosperity Bancshares. The stock has traded at an average P/TB ratio of 2.17x in the past, as shown below.

The stock has traded at an average P/E ratio of around 13.6x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $78.1 , which implies a 7.2% upside from the current market price. Adding the forward dividend yield gives a total expected return of 9.9%. As this expected return is not high enough for me, I’m adopting a hold rating on Prosperity Bancshares.

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