UNTY - Unity Bancorp: Attractively Valued With A Positive Outlook For Topline Growth

Summary

• Job markets will likely sustain loan growth. However, growth will most probably decline from the second quarter’s unsustainable level.
• The margin will likely be less rate-sensitive in the future as deposits will take a lagged hit from interest rate hikes.
• High inflation will likely worsen the credit quality, leading to higher provisions.
• The December 2022 target price suggests a high upside from the current market price. Further, UNTY is offering a low dividend yield.

The earnings of Unity Bancorp, Inc. ( UNTY ) will most probably surge this year on the back of moderately high loan growth. Further, the top line will benefit from a rising rate environment. On the other hand, inflation-driven provision expenses will restrict earnings growth. Overall, I'm expecting Unity Bancorp to report earnings of $3.66 per share for 2022, up 7% year-over-year. Compared to my last report on the company, I've increased my earnings estimate because I've revised upwards both the loan growth and margin estimates. For 2023, I'm expecting earnings to increase by a further 7% to $3.92 per share. The year-end target price suggests a high upside from the current market price. Therefore, I'm maintaining a buy rating on Unity Bancorp.

Strong Job Markets to Keep Loan Growth from Slowing Down too Much

Like many peer banks, Unity Bancorp’s loan growth during the second quarter of 2022 was exceptionally high. The portfolio grew by 5.9% during the quarter, or 24% annualized, which beat my expectations. The high growth was partly attributable to borrowers pulling their borrowing requirements to an earlier time to lock in rates before they increase too much. Such preemptive borrowing will make loan growth significantly slow down in future quarters.

Nevertheless, I’m optimistic about loan growth because of strong job markets. Unity Bancorp serves businesses and individuals across New Jersey and some parts of Pennsylvania. Further, the loan portfolio is well diversified across segments ranging from commercial real estate loans to residential mortgages. Therefore, broad-based, state-wide economic metrics are appropriate gauges of Unity Bancorp’s product demand. The states’ unemployment rates continue to remain near record lows from a historical perspective, which bodes well for loan growth.

Further, the coincident indices show a satisfactory level of economic activity.

Considering these factors, I'm expecting the portfolio to grow by 2% every quarter till the end of 2023. This will lead to loan growth of 13.7% for 2022. In my last report on Unity Bancorp, I estimated loan growth of 11.1% for 2022. I've increased my loan growth estimate mostly because of the second quarter's outstanding performance. Meanwhile, I'm expecting deposits to mostly grow in line with loans. The following table shows my balance sheet estimates.

In my last report on Unity Bancorp, I estimated earnings of $3.44 per share for 2022. I've increased my earnings estimate mostly because I've revised upwards both my loan growth and margin estimates.

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.

High Price Upside Calls for a Buy Rating

Unity Bancorp regularly increases its dividend, usually in the second quarter of the year. Given the earnings outlook, I’m expecting the company to increase its dividend by $0.01 per share to $0.12 per share in the second quarter of 2023. The earnings and dividend estimates suggest a payout ratio of 12% for 2023, which is close to the five-year average of 14%. Based on my dividend estimate, Unity Bancorp is offering a forward dividend yield of 1.8%.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Unity Bancorp. The stock has traded at an average P/TB ratio of 1.34 in the past, as shown below.

The stock has traded at an average P/E ratio of around 8.6x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $30.6 , which implies an 18.8% upside from the current market price. Adding the forward dividend yield gives a total expected return of 20.6%. Hence, I’m maintaining a buy rating on Unity Bancorp.

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