CATY - Recent Price Correction Makes Cathay General Bancorp Quite Attractive

2023-03-27 07:30:41 ET

Summary

• Regional economic factors will likely sustain loan growth this year.
• The rate of margin expansion will dip this year due to the continued worsening of the deposit mix.
• CATY’s exposure to California and venture capital assets has increased its riskiness. However, the earnings at risk aren’t a cause for concern.
• The December 2023 target price suggests a very high upside from the current market price. Further, CATY is offering a high dividend yield of 4.0%.

The earnings of Cathay General Bancorp (CATY) will continue to grow this year on the back of moderate loan growth and slight margin expansion. As a result, I'm expecting the company to report earnings of $5.29 per share for 2023, up 9% year-over-year. Compared to my last report on the company, I've decreased my earnings estimate because I've reduced my loan growth estimate. The company's risk level has increased amid the ongoing banking crisis because it operates in the same market as the failed banks and it has some venture capital investments. Nevertheless, the recent plunging of Cathay's stock price amid the banking crisis appears like an overreaction. Following the recent correction, the company is offering a very high price upside. Based on the total expected return and the risk level, I'm maintaining a buy rating on Cathay General Bancorp.

Factors Affecting Loan Growth are Mixed

Cathay General's loan growth continued to decelerate during the last quarter. The portfolio grew by just 0.8% during the quarter, or 3.3% annualized, which took the full-year loan growth to 11.7%. Going forward, the management isn't expecting much improvement over the last quarter's level. As mentioned in the earnings presentation , the management is expecting loan growth of 3% to 5% for 2023.

Economic factors are currently presenting a mixed outlook for loan growth. Cathay General caters to high-density Asian-populated urban areas across the country, especially in California and New York. Most labor markets in urban California are currently doing quite well, while New York City is lagging, as shown below.

Further, the high interest rate environment will hurt credit demand. Overall, I'm expecting the loan portfolio to grow by 4% in 2023. Compared to my last report on the company, I've reduced my growth estimate by around a hundred basis points because my outlook isn't as bright as before. The following table shows my balance sheet estimates.

In my last report on the company, I estimated earnings of $5.44 per share for 2023. I've reduced my earnings estimate mostly because I've decreased my loan growth estimate.

Market's Reaction to the Increase in Riskiness Appears Overblown

Cathay General's stock price has plunged by 17.5% since March 8, 2023, when the current banking crisis started. The panic may be attributable to the fact that Cathay operates in California, just like the failed U.S. Banks (SVB Financial, SIVB , Signature Bank, SBNY , and Silvergate Capital, SI ), so there is some market overlap. Further, Cathay General owns a venture capital firm called GBC Venture Capital. However, the exposure is limited as the fair value of venture capital assets was just $0.689 million at the end of December 2022, as mentioned in the 10-K Filing.

I believe the market's reaction is overblown because Cathay General's earnings at risk aren't that high. If the recent bank failures spread to other banks, then I'm not too worried because the company doesn't have high unrealized losses. Cathay's unrealized losses amounted to $149.5 million at the end of December 2022. To put this number in perspective, $149.5 million is 6% of the equity outstanding at the end of 2022 and 41% of the net income for last year. Therefore, even in case of contagion, Cathay's loss will be limited.

Further, Cathay does not have material exposure to risky assets like digital tokens and crypto assets.

Maintaining a Buy Rating Due to the Risks

Cathay General is offering a dividend yield of 4.0% at the current quarterly dividend rate of $0.34 per share. The earnings and dividend estimates suggest a payout ratio of 26% for 2022, which is below the five-year average of 37%. Cathay General does not increase its dividend regularly; therefore, I'm not expecting a dividend hike this year even though the implied payout ratio shows that there is room for a dividend hike.

I'm using the historical price-to-tangible book ("P/TB") and price-to-earnings ("P/E") multiples to value Cathay General. The stock has traded at an average P/TB ratio of 1.38x in the past, as shown below.

The stock has traded at an average P/E ratio of around 9.7x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $46.7 , which implies a 36.7% upside from the current market price. Adding the forward dividend yield gives a total expected return of 40.7%. Although the total expected return calls for a Strong Buy, I'm adopting only a Buy rating on Cathay General Bancorp because of the risks.

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