Peoples Bancorp's Bottom Line Likely To Gradually Improve
- After the loss in the first quarter, earnings will likely improve in the remainder of the year due to a downwards trend in provision expense.
- Acquisition of Triumph Premium Finance will also contribute to an improvement in the bottom line in the remainder of the year.
- Despite the improvement, earnings will likely remain below normal in the remaining nine months of the year.
- The severity and duration of COVID-19 are unknown, which could lead to earnings surprises. Consequently, PEBO should trade at a discount to its target price determined through the price-to-book method.
Peoples Bancorp, Inc. (NASDAQ:PEBO) made a loss of $0.04 per share in the first quarter on the back of a hike in provision expense. For the remaining nine months of the year, the provision expense will likely trend downwards as PEBO incorporated a reasonably bleak economic outlook in its reserves for the first quarter. PEBO's acquisition of Triumph Premium Finance will also support earnings in the remaining nine months of the year. Moreover, the company's participation in the Paycheck Protection Program will support earnings. Despite the improvement, earnings will likely remain below normal in the remainder of the year. I'm expecting PEBO's earnings per share to decline by 42% year-over-year to $1.54 in 2020. The December 2020 target price suggests a substantial price upside from the current market price. However, the impact of COVID-19 on provision expense is uncertain, which poses risks to the earnings and valuation. Consequently, I'm adopting a neutral rating on PEBO.
Worst of the Provisioning Over in the First Quarter
PEBO posted a provision expense of $17 million in the first quarter, up from $1.1 million in the fourth quarter of 2019. PEBO appears to have incorporated most of the impact of COVID-19 in its reserves for loan losses in the first quarter. However, I believe the company will have to further increase its reserves as the outlook on unemployment has worsened since the first quarter. As mentioned in the first quarter's conference call, around 65% of the portfolio is tied to US unemployment, and the remaining part is mostly tied to Ohio unemployment and GDP.
PEBO has very limited exposure to industries that have been hit hard by the COVID-19 pandemic. As mentioned in the investor presentation, around $70.6 million, or 2.4% of total loans are to the hotels and lodging industry, while around 0.2% of total loans are to the energy industry. Considering these factors, I'm expecting PEBO to report provision expense of $28 million in 2020, up from $2.5 million in 2019.
Acquisition of Triumph Premium Finance to Support Earnings
PEBO plans to acquire the operations and assets of Triumph Premium Finance ("TPF"), a division of TBK Bank, SSB, in the third quarter of 2020, according to the earnings release. TPF provides premium finance services for customers to purchase property and casualty insurance products. The management expects TPF to add $0.02 to $0.04 per share, or approximately $411,000 to $822,000 to the net income in 2020 (excluding one-time acquisition costs). Due to the acquisition, I'm expecting non-interest income to increase by 2% in the second quarter on a linked quarter basis. For the full year, I'm expecting non-interest income to decline by 0.3% as the fall in the first quarter will likely cancel out the increase in non-interest income in the second half of the year.
The acquisition will lead to one-time costs of $500,000 to $750,000, or approximately $410,000 to $615,000 on an after-tax basis. The one-time acquisition cost will likely drive up non-interest expense in the remainder of the year. On the other hand, efforts to control expenses will likely constrain the growth in non-interest expenses. The management expects to limit its core non-interest expense to between $33 and $34 million per quarter (excluding acquisition costs) in the remainder of the year compared to $34.3 million in the first quarter. Overall, I'm expecting PEBO's non-interest expense to decline by just 0.1% year-over-year in 2020.
Loan Growth and CD Maturity to Offset Interest Rate Headwinds
PEBO's net interest margin, NIM, declined by 8bps in the first quarter due to the federal funds rate cuts. The March cuts will compress NIM further in the second quarter due to the full quarter impact. Moreover, the Paycheck Protection Program, PPP, loans will squeeze NIM in the second quarter because they carry a relatively low fee. On the other hand, the maturity of promotional deposits this year will support NIM. According to details given in the latest 10-K filing, around 68% of PEBO's certificates of deposits are scheduled to mature this year. Overall, I'm expecting PEBO's NIM to decline by 15bps in the second quarter, and to recover by 6bps in the last quarter due to some PPP prepayment. For the full year, I'm expecting NIM to drop by 32bps, as shown below.
Continued loan growth will likely offset NIM compression in the remainder of the year. I'm expecting loans to increase by 7% in the second quarter over the first quarter due to PEBO's participation in PPP. However, early repayment of some of those loans will likely reduce the loan balances by the fourth quarter. Overall, I'm expecting PEBO's net loans to grow by 2.8% year-over-year in 2020.
As mentioned in the presentation, the management expects PPP to add around $15 million to pre-tax net income. Considering the impact of NIM compression and PPP, I'm expecting the net interest income to decline by just 0.8% year-over-year in 2020.
Estimating Earnings Per Share of $1.54 for 2020
The downward trend in provision expense, acquisition of TPF, and participation in PPP will likely lead to an improvement in the bottom line for the remainder of the year. However, earnings will likely remain below normal due to higher than usual provision expense. For the full year, I'm expecting PEBO's earnings to decline by 42% year-over-year to $1.54 per share. The following table shows my income statement estimates.
The impact of COVID-19 on provision expense in the remaining three quarters of the year is still uncertain as the severity and duration of the pandemic are unknown. The pandemic can lead to further earnings surprises and losses in the future. Therefore, I believe that presently risks are at a high level for PEBO.
I'm expecting PEBO to maintain its quarterly dividend at the current level of $0.34 per share. I'm not expecting a cut because the dividend and earnings estimates suggest a payout ratio of 88% for 2020, which is manageable. The dividend estimate for 2020 suggests a dividend yield of 6.4%.
Discount to Target Price Seems Justified
I'm using the average price-to-tangible-book ratio, P/TB, to value PEBO. As shown in the following table, the stock has traded at an average P/TB multiple of 1.58 in the past.
Multiplying this average P/TB ratio with the forecast tangible book value per share of $20.3 gives a target price of $32.1 for December 2020. This price target implies an upside of 51% from PEBO's May 7 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The upside indicates PEBO's high return potential. However, as mentioned above, PEBO is also quite risky. Due to the risks and uncertainties, I believe PEBO should currently trade at a discount to its target price; therefore, I'm adopting a neutral rating on the stock.
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