Summary
- Loan growth will likely slow down due to various economic factors.
- A lagged effect of last year's rate hikes will lift earnings this year. However, an increase in the deposit beta will restrict margin growth.
- Operating efficiency is likely to improve due to branch optimization efforts.
- The December 2023 target price suggests a small upside from the current market price. Further, HTLF is offering a low dividend yield.
Earnings of Heartland Financial USA, Inc. ( HTLF ) will most probably surge this year on the back of higher loan balances. Further, the lagged effect of last year's interest rate hikes will boost the margin this year, which will, in turn, support the bottom line. Further, an improvement in operating efficiency following recent branch closures will help earnings. Overall, I’m expecting Heartland Financial to report earnings of $5.44 per share for 2023, up 14% year-over-year. The December 2023 target price suggests a small upside from the current market price. Therefore, I'm adopting a hold rating on Heartland Financial USA, Inc.
Significant Loan Growth Slowdown is Likely
Heartland Financial’s loan growth remained remarkably strong during the fourth quarter of 2022, rising by 4.6%, which took the full-year loan growth to 15.0%. The management mentioned in the conference call that it expects loan growth of $150 million to $200 million for the first quarter of 2022, which translates to a growth of around 1.3% to 1.8%. This is a significant slowdown from the fourth quarter's growth of 4.6%, and quite low compared to previous years. Further, the management expects loan growth of just 6% to 8% for 2023, which is much below the last five-year compounded annual growth rate of 12%.
A slowdown is only natural given the ongoing steep up-rate cycle. Heartland Financial’s network is well diversified with a presence in several states across the West/Southwest and Midwest United States. Further, Heartland’s loan portfolio is concentrated on commercial real estate (“CRE”) and commercial industrial (“C&I”) loans. As a result, broad national economic metrics, like the unemployment rate, are good gauges of credit demand. As shown below, unemployment continues to remain near record lows and is showing no signs of relenting.
The U.S. leading economic indicator is another appropriate gauge of credit demand. The index’s decline has steepened in the last six months compared to the previous six-month period.
Considering these factors, I'm expecting the loan growth to decline to 6% in 2023. Further, I'm expecting deposits to grow somewhat in line with loans. The following table shows my balance sheet estimates.
Financial Position | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net Loans | 7,346 | 8,298 | 9,891 | 9,844 | 11,319 | 12,013 |
Growth of Net Loans | 15.9% | 13.0% | 19.2% | (0.5)% | 15.0% | 6.1% |
Other Earning Assets | 2,890 | 3,638 | 6,472 | 7,994 | 7,112 | 7,328 |
Deposits | 9,396 | 11,044 | 14,980 | 16,417 | 17,513 | 18,588 |
Borrowings and Sub-Debt | 608 | 458 | 625 | 504 | 748 | 771 |
Common equity | 1,325 | 1,578 | 1,969 | 2,071 | 1,624 | 1,805 |
Book Value Per Share ($) | 39.9 | 43.8 | 52.7 | 48.8 | 38.1 | 42.3 |
Tangible BVPS ($) | 26.7 | 30.0 | 36.1 | 34.5 | 24.0 | 28.2 |
Source: SEC Filings, Author's Estimates(In USD million unless otherwise specified) |
Lagged Effect of Interest Rate Hikes to Boost the Margin this Year
Heartland Financial’s margin growth remained satisfactory during the fourth quarter of 2022. The margin expanded by 20 basis points during the quarter, as opposed to a growth of 27 basis points in the third quarter and 10 basis points in the second quarter of the year. Margin expansion will likely continue strongly in 2023 as the uprate cycle nears its end. This is because Heartland's loans are slower to reprice than deposits. The results of the management's rate-sensitivity analysis given in the third quarter’s 10-Q filing showed that while a 200-basis points hike in interest rates could boost the net interest income by only 0.82% in the first year, it could boost the net interest income by a sizable 6.59% in the second year of the rate hike.
3Q 2022 10-Q Filing
On the other hand, the deterioration of the deposit beta will restrict margin growth. The management expects the deposit beta to tick up as Heartland moves deposit rates closer to the market, according to details given in the conference call.
Considering these factors, I'm expecting the margin to grow by around 20 basis points in 2023.
Slight Improvement in Operating Efficiency to Support Earnings
Heartland Financial is all set to save costs through recent branch optimization efforts. The company reduced its branch network from 130 branches to 119 branches in 2022, as mentioned in the earnings presentation .
On the other hand, inflationary pressures on salary expenses will boost non-interest expense growth. Further, the tight labor market is bound to push up salary expenses. Moreover, the charter consolidation initiative will lead to some one-off expenses. As mentioned in the presentation, Heartland is planning to complete the consolidation of 11 existing bank charters into one, HTLF Bank, by 4Q 2023. Due to the consolidation, the management expects to book expenses of $10 to $11 million this year. However, this consolidation will save costs in the longer run.
Overall, I'm expecting the efficiency ratio to improve to 60.2% in 2023 from 61.0% in 2022 and 62.6% in 2021. I'm expecting the non-interest expense quarterly run rate to hover around $123 million, which is higher than the management's target given in the conference call. (Target was $108 million to $109 million for recurring non-interest expenses). In my opinion, the management’s target is too ambitious given the inflationary environment and the tight labor market.
Apart from the improvement in operating efficiency, the anticipated loan growth and margin expansion will support earnings this year. Overall, I'm expecting Heartland Financial to report earnings of $5.44 per share for 2023, up 14% year-over-year. The following table shows my income statement estimates.
Income Statement | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
Net interest income | 414 | 434 | 492 | 561 | 598 | 700 |
Provision for loan losses | 24 | 17 | 67 | (18) | 15 | 24 |
Non-interest income | 109 | 116 | 120 | 129 | 128 | 115 |
Non-interest expense | 354 | 349 | 371 | 432 | 443 | 490 |
Net income - Common Sh. | 117 | 149 | 133 | 212 | 204 | 232 |
EPS - Diluted ($) | 3.52 | 4.14 | 3.57 | 5.00 | 4.79 | 5.44 |
Source: SEC Filings, Earnings Releases, Author's Estimates(In USD million unless otherwise specified) |
My estimates are based on certain macroeconomic assumptions that may not come to fruition. Therefore, actual earnings can differ materially from my estimates.
Total Expected Return is Not High Enough for a Buy Rating
Heartland Financial is offering a dividend yield of 2.4% at the current quarterly dividend rate of $0.30 per share. The earnings and dividend estimates suggest a payout ratio of 22% for 2022, which is close to the five-year average of 19%. Therefore, I’m not expecting another increase in the dividend level this year.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Heartland Financial. The stock has traded at an average P/TB ratio of 1.58 in the past, as shown below.
FY18 | FY19 | FY20 | FY21 | FY22 | Average | |
T. Book Value per Share ($) | 26.7 | 30.0 | 36.1 | 34.5 | 24.0 | |
Average Market Price ($) | 55.1 | 45.5 | 36.1 | 48.4 | 46.5 | |
Historical P/TB | 2.07x | 1.52x | 1.00x | 1.40x | 1.94x | 1.58x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/TB multiple with the forecast tangible book value per share of $28.2 gives a target price of $44.8 for the end of 2023. This price target implies a 9.9% downside from the February 22 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
P/TB Multiple | 1.38x | 1.48x | 1.58x | 1.68x | 1.78x |
TBVPS - Dec 2023 ($) | 28.2 | 28.2 | 28.2 | 28.2 | 28.2 |
Target Price ($) | 39.1 | 41.9 | 44.8 | 47.6 | 50.4 |
Market Price ($) | 49.7 | 49.7 | 49.7 | 49.7 | 49.7 |
Upside/(Downside) | (21.3)% | (15.6)% | (9.9)% | (4.3)% | 1.4% |
Source: Author's Estimates |
The stock has traded at an average P/E ratio of around 11.2x in the past, as shown below.
FY18 | FY19 | FY20 | FY21 | FY22 | Average | |
Earnings per Share ($) | 3.52 | 4.14 | 3.57 | 5.00 | 4.79 | |
Average Market Price ($) | 55.1 | 45.5 | 36.1 | 48.4 | 46.5 | |
Historical P/E | 15.7x | 11.0x | 10.1x | 9.7x | 9.7x | 11.2x |
Source: Company Financials, Yahoo Finance, Author's Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $5.44 gives a target price of $61.2 for the end of 2023. This price target implies a 23% upside from the February 22 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
P/E Multiple | 9.2x | 10.2x | 11.2x | 12.2x | 13.2x |
EPS 2023 ($) | 5.44 | 5.44 | 5.44 | 5.44 | 5.44 |
Target Price ($) | 50.3 | 55.7 | 61.2 | 66.6 | 72.0 |
Market Price ($) | 49.7 | 49.7 | 49.7 | 49.7 | 49.7 |
Upside/(Downside) | 1.1% | 12.1% | 23.0% | 34.0% | 44.9% |
Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $53.0 , which implies a 6.6% upside from the current market price. Adding the forward dividend yield gives a total expected return of 9.0%. Hence, I’m adopting a hold rating on Heartland Financial USA, Inc. While the earnings prospects are good, the stock price does not appear to be attractive. I would only consider investing in Heartland Financial if its price dipped by more than 5% from the current level.
For further details see:
Heartland Financial: Prospects Of Sizable Earnings Growth Appear Priced-In