- Loan growth will decelerate due to high interest rates and falling consumer confidence. Nevertheless, it will remain near the historical average thanks to commercial loans.
- The top line is only moderately sensitive to rate changes.
- Higher interest rates will continue to drag the equity book value per share, which will hurt equity valuation.
- The December 2022 target price suggests a significant downside from the current market price. Further, CBSH is offering a low dividend yield.
Moderate loan growth that's in line with the historical average will likely support the earnings of Commerce Bancshares, Inc. (CBSH) through the end of 2023. Further, the moderately rate-sensitive topline will benefit from higher interest rates. On the other hand, higher net provision expense will drag earnings. Overall, I'm expecting Commerce Bancshares to report earnings of $3.97 per share for 2022, down 8% year-over-year. Compared to my last report on the company, I've tweaked upwards my earnings estimate mostly because I've increased both my loan growth and margin estimates. The year-end target price suggests a significant downside from the current market price. Based on the total expected return, I'm adopting a hold rating on Commerce Bancshares.
Loan Growth To Decelerate
Commerce Bancshares loan growth continued to beat my expectations in the second quarter of 2022. The portfolio grew by 1.5% in the second quarter of 2022, bringing the first half growth to 3.5% (7% annualized).
Around 63% of the loan portfolio is made up of commercial loans, as mentioned in the earnings presentation . Therefore, the purchasing managers’ index is a good gauge for product demand. Although the index has recently been on a downtrend, it is still in expansionary territory (above 50), which bodes well for loan growth.
For consumer loans, the outlook is less bright. The consumer confidence index has continued to drop so far this year. Moreover, due to high interest rates, consumers wanting to borrow for less pressing expenditures will prefer to wait until borrowing costs decline.
Considering these factors, I'm expecting loan growth to return to the historical norm of the mid-single-digit range for the second half of 2022 and the full year of 2023. In my last report , I anticipated loan growth of 5.1% for 2022. I have now decided to tweak it upwards to 5.6% mostly because of the second quarter’s performance.
Book Value Has Taken A Hit from Higher Interest Rates
The surge in interest rates so far this year has eroded Commerce Bancshares’ equity book value. This is because increase in rates decreased the value of fixed-rate investment securities. This unrealized loss flowed directly into equity bypassing the income statement. By the end of June 2022, the book value per share had declined by $2.31 from the end of March 2022 and $6.18 from the end of June 2021, as mentioned in the earnings presentation.
Going forward, further equity book value erosion is on the cards as I'm expecting the federal funds rate to increase by a further 75 basis points in the remainder of the year, before plateauing and then trending downwards in the second half of 2023. The following table shows my balance sheet estimates.
FY18 | FY19 | FY20 | FY21 | FY22E | FY23E | |
Financial Position | ||||||
Net Loans | 13,980 | 14,577 | 16,109 | 15,026 | 15,861 | 16,505 |
Growth of Net Loans | 1.1% | 4.3% | 10.5% | (6.7)% | 5.6% | 4.1% |
Other Earning Assets | 10,113 | 9,988 | 15,288 | 20,299 | 16,280 | 16,941 |
Deposits | 20,324 | 20,520 | 26,947 | 29,813 | 28,567 | 29,727 |
Borrowings and Sub-Debt | 1,965 | 1,853 | 2,099 | 3,036 | 2,152 | 2,239 |
Common equity | 2,787 | 2,990 | 3,397 | 3,437 | 2,840 | 3,223 |
Book Value Per Share ($) | 24.8 | 26.0 | 29.1 | 28.4 | 23.7 | 26.9 |
Tangible BVPS ($) | 23.5 | 24.7 | 27.9 | 27.1 | 22.4 | 25.6 |
Source: SEC Filings, Author's Estimates (In USD million unless otherwise specified) |
It needs to be mentioned here that despite the decline in equity book value, the capital adequacy ratios are still at comfortable levels. The tier I ratio stood at 13.9% at the end of June 2022, as opposed to the minimum regulatory requirement of 8.5%. Therefore, the book value drop does not pose any risk to dividend payments.
Margin is Only Moderately Rate Sensitive
Variable-rate loans comprised around 53% of the loan portfolio at the end of December 2021, as mentioned in the earnings presentation. Therefore, the average portfolio yield will benefit to a moderate extent from a hike in interest rates. Within the securities portfolio, the management expects maturities and pay downs of $2.2 billion over the next twelve months. To put this number in perspective, $2.2 billion is 16% of total securities. This part of the securities portfolio will further enable the average yield to respond to higher interest rates.
The management’s simulation model for rate sensitivity given in the 10-Q filing also shows that the net interest margin is only moderately sensitive to rate changes. A 200-basis points hike in interest rates could boost the net interest income by 4.01% over twelve months, assuming a static balance sheet.
2Q 2022 10-Q Filing
Considering these factors, I'm expecting the margin to expand by 20 basis points in the second half of 2022 before plateauing through the end of 2023. Compared to my last report, I've tweaked upwards my margin estimate because my interest rate outlook is more hawkish than before.
Excessive Coverage to Keep Further Provisioning Below Normal
Last year, Commerce Bancshares reported a large provision reversal as the economy recovered quicker than expected from the pandemic. As the recovery is complete, further reversals are highly unlikely. Nevertheless, the provisioning expense, net of reversals, will most probably remain below normal through the end of 2023 because of heightened reserve levels. The allowances rose to 17.4 times the non-accruing loans at the end of June 2022 from 15.4 times of non-accruing loans at the end of June 2021. This allowance level is quite high relative to peers.
2Q 2022 Earnings Presentation
Due to the excessively high coverage, I believe Commerce Bancshares can easily ride out a short recession without further bolstering its reserves. Therefore, I believe provisioning will likely remain below normal for the remainder of 2022 and full-year 2023. I'm expecting a net provision expense (annualized) of point 0.16% of total loans for the second half of 2022 and 0.17% of total loans for 2023. In comparison, the net provision expense averaged 0.28% of total loans in the last five years.
Expecting Earnings to Dip by 8%
The anticipated loan additions and moderate margin expansion will support earnings this year. On the other hand, higher provision expenses, net of reversals, will drag earnings. Moreover, the noninterest income will likely decline this year as last year’s one-off income, especially the gain on the sale of land, will not recur.
Overall, I'm expecting Commerce Bancshares to report earnings of $3.97 per share for 2022, down 8% year-over-year. For 2023, I'm expecting earnings to grow by 7% year-over-year to $4.26 per share. The following table shows my income statement estimates.
FY18 | FY19 | FY20 | FY21 | FY22E | FY23E | |
Income Statement | ||||||
Net interest income | 824 | 821 | 830 | 835 | 929 | 1,002 |
Provision for loan losses | 43 | 50 | 137 | (66) | 11 | 28 |
Non-interest income | 501 | 525 | 506 | 560 | 552 | 578 |
Non-interest expense | 738 | 767 | 768 | 806 | 853 | 882 |
Net income - Common Sh. | 425 | 412 | 339 | 526 | 476 | 510 |
EPS - Diluted ($) | 3.78 | 3.58 | 2.91 | 4.31 | 3.97 | 4.26 |
Source: SEC Filings, Author's Estimates (In USD million unless otherwise specified) |
In my last report on Commerce Bancshares, I estimated earnings of $3.82 per share for 2022. I've revised upwards my earnings estimate because I've tweaked 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.
Current Market Price is Above the Target Price
Commerce Bancshares is offering a dividend yield of 1.5% at the current quarterly dividend rate of $0.265 per share. The earnings and dividend estimates suggest a payout ratio of 25% for 2023, which is close to the five-year average of 30%. Although there is room for a dividend hike, I’ve incorporated no change in the dividend for my investment thesis to remain on the safe side. Commerce Bancshares also usually gives a 5% stock dividend in the fourth quarter of the year.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Commerce Bancshares. The stock has traded at an average P/TB ratio of 2.28 in the past, as shown below.
FY17 | FY18 | FY19 | FY20 | FY21 | Average | |
T. Book Value per Share ($) | 21.6 | 23.5 | 24.7 | 27.9 | 27.1 | |
Average Market Price ($) | 48.7 | 55.2 | 55.1 | 55.5 | 69.7 | |
Historical P/TB | 2.26x | 2.35x | 2.23x | 1.99x | 2.57x | 2.28x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/TB multiple with the forecast tangible book value per share of $22.4 gives a target price of $51.1 for the end of 2022. This price target implies a 29.2% downside from the August 11 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
P/TB Multiple | 2.08x | 2.18x | 2.28x | 2.38x | 2.48x |
TBVPS - Dec 2022 ($) | 22.4 | 22.4 | 22.4 | 22.4 | 22.4 |
Target Price ($) | 46.6 | 48.8 | 51.1 | 53.3 | 55.5 |
Market Price ($) | 72.1 | 72.1 | 72.1 | 72.1 | 72.1 |
Upside/(Downside) | (35.4)% | (32.3)% | (29.2)% | (26.1)% | (23.0)% |
Source: Author's Estimates |
The stock has traded at an average P/E ratio of around 16.6x in the past, as shown below.
FY17 | FY18 | FY19 | FY20 | FY21 | Average | |
Earnings per Share ($) | 2.76 | 3.78 | 3.58 | 2.91 | 4.31 | |
Average Market Price ($) | 48.7 | 55.2 | 55.1 | 55.5 | 69.7 | |
Historical P/E | 17.7x | 14.6x | 15.4x | 19.1x | 16.2x | 16.6x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $3.97 gives a target price of $65.8 for the end of 2022. This price target implies an 8.7% downside from the August 11 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
P/E Multiple | 14.6x | 15.6x | 16.6x | 17.6x | 18.6x |
EPS 2022 ($) | 3.97 | 3.97 | 3.97 | 3.97 | 3.97 |
Target Price ($) | 57.9 | 61.8 | 65.8 | 69.8 | 73.8 |
Market Price ($) | 72.1 | 72.1 | 72.1 | 72.1 | 72.1 |
Upside/(Downside) | (19.7)% | (14.2)% | (8.7)% | (3.2)% | 2.3% |
Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $58.4 , which implies a 19.0% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 17.5%.
Considering the cash and stock dividends and the price downside, I'm adopting a hold rating on Commerce Bancshares.
For further details see:
Commerce Bancshares: Topline Outlook Is Rosy But Stock Appears Overvalued