Is Bank Of Montreal A Buy Or A Hold?
Summary
- Bank of Montreal is the fourth-largest bank in Canada.
- The bank has a strong capital position and an improving PCL.
- BMO has a relatively lower exposure to the Canadian housing market than its industry peers.
- Its presence in the Canadian ETF market should provide a long runway of growth for its wealth management business.
Investment Thesis
Bank of Montreal (NYSE:BMO) (TSX:BMO) is the fourth-largest bank in Canada. The bank has a strong capital position and an improving PCL. Compare to its Canadian peers, BMO has a relatively lower exposure to the Canadian housing market. Its presence in the Canadian ETF market should provide a long runway of growth for its wealth management business. However, its shares are currently fairly valued based on comparative PE analysis. Investors may want to patiently wait for a better entry point.
Source: YCharts.com
Reasons Why Bank of Montreal is a Buy
Strong Capital Position
BMO's strong capital position is evident in its Common Equity Tier 1 (“CET1”) ratio. For readers who are not familiar with the term, CET1 is a measure of a bank’s capital against its assets. BMO’s CET1 ratio in Q1 2018 was 11.1%. Despite a 30 basis points decline, we note that its internal capital generation was strong at 28 basis points. The decline was mostly due to DTA charge, share buybacks, and higher source currency RWA. BMO’s CET1 is slightly better than Royal Bank's (RY) 11%, CIBC's (CM) 10.8%, and TD Bank's (TD) 10.6%.
Source: Q1 2018 Investor Presentation
Improving PCL
BMO’s Provision For Credit Losses (“PCL”) improved considerably in Q1 2018. In fact, its PCL on impaired loans reduced to C$174 million. This is the third consecutive improvement quarter over quarter. While its PCL on impaired loan increased by C$7 million year over year, its total PCL decreased to C$141 million in Q1 2018, from C$167 million in Q1 2017.
Source: Q1 2018 Investor Presentation
An Excellent track record of dividend payout history.
BMO has an excellent track record of dividend payout history. In fact, the bank has paid dividends to its shareholders for more than 189 years. This is the longest running dividend payout record of any company in Canada. Its dividend is expected to be C$3.72 in 2018. This is equivalent to a dividend yield of 3.9%. As we can see from the chart below, even during the Great Recession, BMO did not cut its dividend.
Source: Q1 2018 Corporate Fact Sheet
Strong growth potential in its ETF products
One of the strengths of BMO is that it is the largest ETF provider among Canada’s top five banks. Currently, BMO is the country’s second largest ETF provider behind BlackRock (BLK). As we know, passive investment has been growing rapidly in the past few years due to its lower management fee than active funds. BMO’s effort and presence in the ETF market in Canada should provide a long runway of growth for its wealth management segment.
Low exposure to the Canadian housing market
Canada’s housing market remains a concern for many investors who want to invest in banking stocks. While a housing market crash does not appear imminent, a soft landing is quite possible, especially after the government introduced a more stringent stress test in January. This slowdown in housing market activities will hurt many banks’ mortgage business. Fortunately, BMO has the lowest exposure to the Canadian housing market among the big five banks. Its total Canadian residential mortgage portfolio is about C106.4 billion or about 28% of its total loans. Despite this relatively lower exposure, investors should be aware that BMO’s business could still be impacted if a housing crisis occurs.
Source: Q1 2018 Investor Presentation
Valuation
Consensus among 13 analysts who cover BMO suggests fiscal 2018 earnings to be about C$8.71 per share. Based on the share price on March 2, BMO’s price to 2018 EPS ratio is 11.1x. This is inline with its five-year average PE ratio (see table below). Its PE ratio also is comparable to the average of 11.2x of its Canadian peers. To derive a target price, we will use the consensus estimate of BMO’s EPS in its fiscal 2019. The estimate is about C$9.28 per share. Using the five-year average PE ratio of 11.1x, we have a target price of C$103. This implies a return of 6.7%. With the dividend, the total return would be about 10.6%.
Share Price (C$) on March 2 | Consensus 18 EPS | Price to 18 EPS Ratio | Consensus 19 EPS | Price to 19 EPS Ratio | 5-year PE Ratio (Forward) | |
Bank of Montreal (BMO) | $96.51 | $8.71 | 11.1 | $9.28 | 10.4 | 11.1 |
TD Bank (TD) | $74.63 | $6.12 | 12.2 | $6.56 | 11.4 | 11.5 |
Royal Bank (RY) | $99.91 | $8.28 | 12.1 | $8.81 | 11.3 | 11.6 |
CIBC (CM) | $115.70 | $11.84 | 9.8 | $12.29 | 9.4 | 10.1 |
Scotiabank (BNS) | $78.90 | $7.09 | 11.1 | $7.57 | 10.4 | 11.1 |
Average | 11.2 | 10.6 | 11.1 |
Source: Created by author; Yahoo Finance
Investor Takeaway
BMO has a strong capital position and an improving PCL. It has a relatively lower exposure to the Canadian housing market than its Canadian peers. In addition, its presence in the Canadian ETF market should provide long runway of growth for its wealth management segment. Moreover, the company has an excellent track record of increasing its dividend. However, according to our calculation, the company’s total return in the next 12 months would only be about 10.6%. Given the volatility of the stock market in 2018, I would recommend waiting patiently for a better entry point.
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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This article was written by
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.
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