2023-04-13 20:45:41 ET
Summary
- Economic factors will keep loan growth from dipping below the historical average.
- I’ve reduced my earnings estimate mostly because I’ve revised upwards my operating expense estimate.
- The risk level is high because of the large balance of unrealized mark-to-market losses on the AFS securities portfolio.
- The year-end target price suggests a small upside from the current market price. Further, CBSH is offering an unattractive dividend yield.
Earnings of Commerce Bancshares, Inc. ( CBSH ) will most probably increase this year on the back of normal loan growth. On the other hand, inflation-driven growth in operating expenses will drag earnings. Meanwhile, I’m expecting the net interest margin to be mostly stable this year. Overall, I’m expecting Commerce Bancshares to report earnings of $4.03 per share for 2023, up 5% year-over-year. The year-end target price suggests a limited upside from the current market price. Further, the company’s risk level is high due to large unrealized losses. Considering these factors, I’m maintaining a hold rating on CBSH stock.
Commercial Loan Segment to Drive the Loan Book
Loan growth continued to remain extraordinarily high in the fourth quarter of 2022. As a result, the loan portfolio grew by 7.5% for 2022, which is much higher than the last five-year CAGR of 3.1%. I’m expecting growth to revert to the historical average this year, mostly because of the high interest-rate environment. Residential real estate loans and revolving home equity, which are most vulnerable to borrowing costs among all loan classes, made up 19.7% of total loans at the end of 2022.
Fortunately, the outlook for commercial loans is a bit better. Even though the unemployment rate is set to rise this year, it’ll still be low compared to the last decade (see chart below). Commerce Bancshares operates in the states of Missouri, Kansas, Illinois, Oklahoma, and Colorado. While these states are geographically clustered together, their economies are quite different. Therefore, I believe it’s best to take national averages when trying to gauge credit demand.
U.S. Bureau of Labor Statistics for History, the Federal Reserve for Projections
The purchasing managers index is another appropriate gauge of credit demand. The manufacturing PMI index gives a negative outlook for commercial loan growth; however, the services PMI index is still in expansionary territory (above 50).
Considering these factors, I’m expecting the loan portfolio to grow by 3% in 2023, which is the same as the CAGR for the last five years. Further, I’m expecting other balance sheet items to grow in tandem with loans. The following table shows my balance sheet estimates.
Financial Position | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net Loans | 13,980 | 14,577 | 16,109 | 15,026 | 16,153 | 16,643 |
Growth of Net Loans | 1.1% | 4.3% | 10.5% | (6.7)% | 7.5% | 3.0% |
Other Earning Assets | 10,113 | 9,988 | 15,288 | 20,299 | 13,783 | 14,201 |
Deposits | 20,324 | 20,520 | 26,947 | 29,813 | 26,187 | 26,982 |
Borrowings and Sub-Debt | 1,965 | 1,853 | 2,099 | 3,036 | 2,851 | 2,938 |
Common equity | 2,787 | 2,990 | 3,397 | 3,437 | 2,465 | 2,635 |
Book Value Per Share ($) | 24.8 | 26.0 | 29.1 | 28.4 | 19.6 | 21.0 |
Tangible BVPS ($) | 23.5 | 24.7 | 27.9 | 27.1 | 18.4 | 19.8 |
Source: SEC Filings, Author's Estimates(In USD million unless otherwise specified) |
Margin Likely to be Stable this Year Despite the Interest Rate Trend
I’m expecting a further 25-50 basis points hike in the fed funds rate till the mid of 2023, which will take the cumulative rate hike this year to 75-100 basis points. Nevertheless, I’m expecting the net interest margin to be mostly stable as the results of the management’s simulation model given in the 10-K filing show that the net interest income is barely rate sensitive.
2022 10-K Filing
The low rate sensitivity is attributable to the asset mix. On the one hand, the large balance of variable-rate loans increases the topline’s rate sensitivity. These loans made up 55% of total loans at the end of 2022, as mentioned in the earnings presentation . However, the rate sensitivity is diminished by the large securities portfolio, which made up 41% of total earning assets at the end of 2022. Most of these securities have fixed rates. Further, as mentioned in the presentation, the portfolio’s average duration was 3.7 years at the end of 2022; therefore, the majority of the securities portfolio won’t mature this year.
Raising my Expense Estimate and Reducing my Earnings Estimate
In my last report on Commerce Bancshares, which was issued in August 2022, I projected the efficiency ratio (calculated as non-interest expenses divided by total revenues) to be around 55.9% in 2023. The disinflation in the economy since that report hasn’t been as big as I expected; therefore, I now believe my previous expectation was too optimistic. Further, the actual efficiency ratio for 2022 was 57.0%, and I think the ratio for 2023 should be higher than 2022, not lower. As a result, I’m now expecting an efficiency ratio of 58.6% for 2023, which leads to non-interest expenses of $924 million. In my last report, I estimated non-interest expenses of $882 million for this year.
The anticipated loan growth discussed above will likely counter the effect of a surge in expenses on the bottom line. Overall, I’m expecting Commerce Bancshares to report earnings of $4.03 per share for 2023, up 5% year-over-year. This updated estimate is lower than my previous estimate of $4.26 per share mostly because of the upward revision of my non-interest expense estimate.
The following table shows my income statement estimates.
Income Statement | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net interest income | 824 | 821 | 830 | 835 | 942 | 1,023 |
Provision for loan losses | 43 | 50 | 137 | (66) | 28 | 32 |
Non-interest income | 501 | 525 | 506 | 560 | 547 | 554 |
Non-interest expense | 738 | 767 | 768 | 806 | 849 | 924 |
Net income - Common Sh. | 425 | 412 | 339 | 526 | 484 | 506 |
EPS - Diluted ($) | 3.78 | 3.58 | 2.91 | 4.31 | 3.85 | 4.03 |
Source: SEC Filings, Author's Estimates(In USD million unless otherwise specified) |
The Risk Level is High Due to Huge Unrealized Losses
Commerce Bancshares has a very large available-for-sale (“AFS”) securities portfolio which is concentrated in mortgage-backed and asset-backed securities and state and municipal obligations. Due to the fixed-rate nature of these securities, their market value fell as interest rates rose last year, leading to huge unrealized losses. As of the end of December 2022, these unrealized losses had grown to $1,501 million, which is a massive 61% of the total equity balance. Further, $1,501 million is more than three times the earnings for 2022. These losses will most probably begin to reverse next year when interest rates start to fall; however, there is a very slim chance that Commerce Bancshares may feel compelled to sell its securities and realize the as-yet-unrealized loss.
Further, a large part of Commerce Bancshares’ deposit book is uninsured. As of the end of last year, these uninsured deposits made up a whopping 43% of total deposits.
On the plus side, Commerce Bancshares does not have exposure to risky assets like crypto-currencies and venture capital investments. The only high-risk segment in its portfolio is the credit card business, which made up just 3.6% of total loans at the end of 2022.
Single-Digit Total Expected Return Calls for a Hold Rating
Commerce Bancshares is offering a dividend yield of 1.9% at the current quarterly dividend rate of $0.27 per share. The earnings and dividend estimates suggest a payout ratio of 27% for 2023, which is in line with the five-year average of 29%. The company also usually gives a 5% stock dividend in the fourth quarter of the year.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Commerce Bancshares. The stock has traded at an average P/TB ratio of 2.58x in the past, as shown below.
FY18 | FY19 | FY20 | FY21 | FY22 | Average | |
T. Book Value per Share ($) | 23.5 | 24.7 | 27.9 | 27.1 | 18.4 | |
Average Market Price ($) | 55.2 | 55.1 | 55.5 | 69.7 | 69.6 | |
Historical P/TB | 2.35x | 2.23x | 1.99x | 2.57x | 3.78x | 2.58x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/TB multiple with the forecast tangible book value per share of $19.8 gives a target price of $51.1 for the end of 2023. This price target implies an 8.8% downside from the April 13 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
P/TB Multiple | 2.38x | 2.48x | 2.58x | 2.68x | 2.78x |
TBVPS - Dec 2023 ($) | 19.8 | 19.8 | 19.8 | 19.8 | 19.8 |
Target Price ($) | 47.1 | 49.1 | 51.1 | 53.1 | 55.0 |
Market Price ($) | 56.0 | 56.0 | 56.0 | 56.0 | 56.0 |
Upside/(Downside) | (15.8)% | (12.3)% | (8.8)% | (5.2)% | (1.7)% |
Source: Author's Estimates |
The stock has traded at an average P/E ratio of around 16.7x in the past, as shown below.
FY18 | FY19 | FY20 | FY21 | FY22 | Average | |
Earnings per Share ($) | 3.78 | 3.58 | 2.91 | 4.31 | 3.85 | |
Average Market Price ($) | 55.2 | 55.1 | 55.5 | 69.7 | 69.6 | |
Historical P/E | 14.6x | 15.4x | 19.1x | 16.2x | 18.0x | 16.7x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $4.03 gives a target price of $67.1 for the end of 2023. This price target implies a 19.8% upside from the April 13 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
P/E Multiple | 14.7x | 15.7x | 16.7x | 17.7x | 18.7x |
EPS 2023 ($) | 4.03 | 4.03 | 4.03 | 4.03 | 4.03 |
Target Price ($) | 59.0 | 63.1 | 67.1 | 71.1 | 75.1 |
Market Price ($) | 56.0 | 56.0 | 56.0 | 56.0 | 56.0 |
Upside/(Downside) | 5.4% | 12.6% | 19.8% | 27.0% | 34.2% |
Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $59.1 , which implies a 5.5% upside from the current market price. Adding the forward dividend yield gives a total expected return of 7.4%. Based on the low total expected return and the high level of risk, I’m maintaining a hold rating on Commerce Bancshares.
For further details see:
Commerce Bancshares: High Risk, Limited Upside Make Stock Unattractive