Earnings of BankUnited, Inc. (NYSE:BKU) are expected to dip in 2020 partly due to an expected compression in margin following the Fed rate cut earlier in March. A rise in provisions charge is also expected to drag earnings. On the other hand, loan growth and trickling in of the benefits from the BankUnited 2.0 program are expected to support the bottom-line. The estimated target price suggests a substantial upside from the current market price due to the recent rout in the market that was triggered by the spread of COVID-19. BKU was in fact trading at a price below its book value per share as of March 6. Such a discount seems unwarranted, which is why I’m adopting a bullish rating on the stock.
Net Interest Income to Take a Hit From Fed's Rate Cut
Net interest margin, NIM, is expected to be one of the biggest contributors to a decline in earnings this year. The 50bps Fed rate cut is expected to exert pressure on yields, which will lead to lowering of NIM. The pressure is expected to be partly offset by a drop in cost following the repricing of deposits. In addition, as mentioned in the fourth quarter conference call, the management is actively working on LIBOR based floors that should partly offset the pressure on yields. Consequently, I’m expecting BKU’s NIM to drop by 5bps in the first quarter and then by 2bps in the second quarter of 2020 on a sequential basis. The following table presents my estimates for NIM.
The compression in NIM is expected to decrease net interest income this year compared to 2019. The effect of lower NIM is likely to be partly offset by growth in loans. The management mentioned in the conference call that there are good growth opportunities in almost all loan segments, and that they expect loan growth to be in mid-single digit range. However, I believe there are certain headwinds that could constrain loan growth, like COVID-19 that is expected to restrain economic growth. Political uncertainty ahead of the elections and risks related to trade relations are also threats that we need to consider. As a result, I’m assuming that BKU’s loan book will grow at a rate that is at the lower end of management’s guided range. I’m expecting the company’s net loans to grow by 4.1% in 2020 over 2019, as shown in the table below.
Overall, I’m expecting the net effect of lower NIM and higher earning assets to lead to a compression in net interest income of 2.3% year over year in 2020. This reduction is expected to be the chief reason for a dip in earnings this year.
Restaurant Businesses Threaten Provisions Charge
Further pressure on the bottom-line is expected to come from a rise in provisions charge. I’m expecting provisions charge to increase this year due to the adoption of the new accounting standard for credit losses, called CECL. Moreover, the operating environment for restaurant businesses has gotten tough which has raised the threat of bad debts. Restaurant franchise businesses are facing issues due to the low unemployment and rise of food delivery apps. The management mentioned that they were closely monitoring this segment for signs of delinquencies. To be prudent, I’ve decided to take higher provisions charge for this segment even though widespread issues are yet to emerge. Consequently, I’m expecting provisions charge to increase to $20 million in 2020 from $9 million in 2019.
BankUnited 2.0 to Offer Some Respite
BKU currently has an ongoing program, called BankUnited 2.0, under which several initiatives are being taken to reduce non-interest costs and increase non-interest revenue. The goal of the program is to reduce costs by $40 million and increase revenues by $20 million. The bulk of the benefit from this program is expected to materialize in 2021, however, some benefits are likely to be seen this year as well. As mentioned in the conference call, BKU is ahead of schedule in implementing the expenses-related initiatives. Mostly due to BankUnited 2.0, I’m expecting BKU’s non-interest income to increase by 3.9% and non-interest expense to decrease by 0.8% year over year in 2020.
Earnings Likely to Decline by 4%
The NIM compression and increase in provisions charge are expected to drag earnings this year. On the other hand, both non-interest income and non-interest expense are expected to support the bottom-line, as discussed above. Loan growth is also expected to limit the decline in earnings. Considering these factors, I’m expecting BKU’s earnings to decline by 5.2% year over year in 2020. On per share basis, earnings are expected to drop by 3.6% to $3.02. The following table presents my estimates for key income statement items.
Due to the prospects of a drop in earnings, I’m expecting BKU to hold its quarterly dividend constant at the current level of $0.23 per share, instead of increasing it. This dividend estimate suggests dividend yield of 3.3% for 2020.
Valuing at $36.7
To value BKU I’m using the historical average price to book multiple, P/B. The stock has traded at an average P/B multiple of 1.14 in 2019. Multiplying this P/B ratio with the projected book value per share of $32.2 gives a target price of $36.7 for December 2020. This target price implies a significant upside of 32.9% from BKU's March 6 closing price. The following table shows sensitivity of the target price to P/B multiple.
The stock is currently trading at a very cheap level, as suggested by the significant price upside. In fact, BKU closed at a price of $27.6 on March 6, 2020, which is below its book value per share. As I’m expecting a decent return on equity of 9.6% for 2020, a market price that is under 1.0 times the book value per share seems too cheap. As a result, I believe the stock is currently undervalued, hence, I’m adopting a bullish rating on BKU.
Investors should be warned that like other banking sector stocks, BKU currently carries high risk due to COVID-19. If the situation gets worse than expected, then coronavirus can make BKU miss my loan growth estimate. In addition, the Fed might want to cut rates even further to counter the effect of COVID-19 on the economy. As I am not expecting any further rate cuts, additional monetary easing will lead to BKU missing my earnings estimates. Due to these risks, I believe investors should consider their own risk tolerance level before deciding to invest in the stock.