Is CIBC A Buy Or A Hold?

Summary

• Canadian Imperial Bank of Commerce is one of the top six banks in Canada.
• The bank continues to improve its efficiency ratio, CET1 ratio, and PCL.
• A slowdown in the Canadian housing market will have a negative impact on CIBC’s business.

Investment Thesis

Canadian Imperial Bank of Commerce (“CIBC”) (CM) (TSX:CM) is one of the top six banks in Canada. The company announced that it would raise its dividend in its latest earnings release. The bank continues to improve its efficiency ratio, CET1 ratio, and PCL. Despite strong growth, a possible slowdown in the Canadian housing market will have a negative impact on CIBC’s business. CIBC is also fairly valued against its historical average. Conservative investors may want to patiently wait for a pullback.

Source: YCharts.com

Reasons why we like CIBC and its business

Double Digit Revenue Growth Continues

CIBC delivered another excellent quarter with double-digit revenue growth of about 13.4% and EPS growth of about 10% year over year. Its latest acquisition of PrivateBancorp delivered a strong quarter with earnings of US$83 million.

Source: Investor Presentation

CIBC raised its dividend

In CIBC’s Q1 fiscal 2018 earnings, the company also announced to increase its quarterly dividend to C$1.33 per share from C$1.30 per share. This dividend is payable on April 27, 2018. This dividend is equivalent to a dividend yield of about 4.5%. This is the second time the company raised its dividend in the past 12 months. As shown in the chart below, the company has an excellent history of increasing its dividend in the past.

Source: YCharts

Improving CET1 Ratio

CIBC’s Common Equity Tier 1 (“CET1”) improved to 11% in Q1 2018 from 10.6% back in Q4 2017 thanks to its internal capital generation and common shares issued. CIBC’s CET1 is much better than the minimum required CET1 ratio of 4.5%. Its result is also comparable to Royal Bank (RY)’s 11% and Bank of Montreal (BMO)’s 11%.

Source: Investor Presentation

Even Better Efficiency Ratio

CIBC’s efficiency ratio improved to 55.1% in Q1 2018 from 56.3% a year ago (or an improvement of 120 basis points year over year). For readers who are not familiar, efficiency ratio is typically used to analyze how well a bank uses its assets and liabilities internally. A lower efficiency ratio means that the bank is more efficient in utilizing its assets and liabilities.

In CIBC’s Canadian Personal & Commercial Banking division, its efficiency ratio of 51.3% in Q1 was also 60 basis points better year over year. Although CIBC is still trailing behind Royal Bank’s 41.5% by a distance but it is only slightly behind Bank of Montreal’s 50%.

Lower PCL

CIBC’s Provision For Credit Losses (“PCL”) improved to C$153 million in Q1 2018. The PCL was significantly lower than its PCL of C$212 million a year ago. For readers who may not know, PCL is an estimation of potential losses that a company might experience due to credit risk. The lower PCL means that CIBC’s consumer credit metrics remain strong.

But we are concerned about the Canadian Housing Market

Although CIBC continued to grow its mortgage portfolio in Canada, the growth is considerably less due to a new stress test mandated by Canada’s banking regulator. As can be seen from the chart below, CIBC’s mortgage balances only increased by C$2 billion quarter over quarter (or about 1% increase) whereas all other quarters prior increased by around C$4 to C$7 billion quarter over quarter. The bank originated about C$9 billion in new mortgages. This number is much less than the C$12 billion in the same quarter last year.

Although a housing bubble is not likely at the present, any slowdown can be detrimental as a significant portion of CIBC’s revenue comes from its mortgages. Even CIBC is not sure how much impact this will be on its business. On its conference call, management indicated that it is still early to know what the impact of the new mortgage rules will be. For readers who may not know, Canadian government imposed a new stress test for home buyers who don't need mortgage insurances.

Source: Investor Presentation

Valuation Analysis

CIBC has historically been trading at a valuation below its Canadian peers. Its 5-year average PE ratio of 10.8x is much lower than Royal Bank’s 12.5x and Toronto Dominion Bank (TD)’s 13.4x. CIBC is currently trading at a PE ratio of 11.0x. This is slightly above its 5-year average. Looking forward, CIBC’s fiscal 2018 EPS is estimated to be about C$11.84 per share. If we use its average PE ratio of 10.8x, we will have a target price of about $127.87. This is only about 9.1% above its current share price of C$117.20.

Investor Takeaway

With the acquisition of PrivateBancorp, CIBC now has a much better platform to grow its business in the United States. It continued to perform well in the past quarter with a better efficiency ratio, CET1 ratio, and PCL. The only major concern that we have is how much its business may be impacted by a slowdown in the Canadian housing market. We will have to observe the trend in the subsequent quarterly results. CIBC appears to be fairly valued as the average return is only about 9.1% a year from now. At the present, I think it may be wise to patiently wait for further pullback before adding more shares.

Note: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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Analyst’s Disclosure: I am/we are long TD, CM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.