Penns Woods Bancorp: Over 5% Dividend Yield, But Limited Price Upside

Summary

• The loan decline trend will likely pause this year because of the economic reopening and easing of restrictions.
• The earnings will likely decline because gains on sales of loans will normalize.
• The year-end target price suggests a limited upside.

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Earnings of Penns Woods Bancorp, Inc. (NASDAQ:PWOD) will likely slightly decrease this year on the back of normalization of gains on sales of loans. Further, the average margin in 2021 will likely be below the average margin for 2020 due to the decline in interest rates last year. On the other hand, I'm expecting the declining loan trend to reverse this year on the back of easing COVID-19 related restrictions and the vaccine rollout. Overall, I'm expecting the company to report earnings of around $2.06 per share in 2021, down 5% from last year. Penns Woods is offering a high dividend yield for a bank holding company. However, the year-end target price suggests that the upside from the current market price is limited. As a result, I'm adopting a neutral rating on Penns Woods Bancorp.

Economic Reopening to Reverse Loan Decline Trend

The loan portfolio of Penns Woods declined for a second consecutive year in 2020. As mentioned in the fourth quarter's earnings release, lending activity began to rebound towards the end of 2020 as business and travel restrictions were lessened.

Penns Woods' banking subsidiaries serve customers in North-Central and North-Eastern Pennsylvania. The state's vaccine rollout is at par with other states so far. According to data maintained by John Hopkins, around 16.08% of Pennsylvania's total population has already been fully vaccinated. As a result, I'm expecting the downward trend of loan portfolio size to reverse this year.

Additionally, Penns Woods does not have to contend with the upcoming Paycheck Protection Program ("PPP") loan forgiveness. PPP loans made up only 0.8% of total loans at the end of last year, according to details given in the earnings release. Overall, I'm expecting the loan portfolio to increase slightly by 0.4% by the end of 2021 from the end of 2020. The following table shows my estimates for loans and other balance sheet items.

Deposit Maturity to Keep the Margin Stable from 4Q's Level

Penns Woods' balance sheet is asset sensitive, meaning that assets are more sensitive than liabilities to interest rate changes. The sensitivity is partly attributable to the loan portfolio mix, which is concentrated in residential real estate. According to details given in the 10-K filing for 2020, residential real estate loans made up 44% of total loans at the end of December. I'm expecting the maturity of some of the residential loans and other fixed-rate loans to pressurize the overall portfolio yield this year.

On the other hand, the upcoming maturity of costly time deposits will likely ease the pressure on the net interest margin. According to details given in the 10-K filing, time deposits totaling $148 million will mature in 2021, representing 9.9% of total deposits. According to details given in the earnings release, the total time deposit portfolio carried a weighted average rate of 1.92% in the fourth quarter. Assuming the company can replace the maturing deposits with deposits carrying rates of around 0.5%, the maturity can result in a 14 basis point reduction in average deposit cost.

Considering these factors, I'm expecting the margin to remain unchanged in each quarter from the fourth quarter of 2020. In this case, the average net interest margin in 2021 will likely be 12 basis points below the average margin for 2020.

Ample Reserves to Ease the Provisioning Pressure

I'm expecting the provision expense to decline slightly in 2021 relative to 2020. The existing loan loss reserves appear high enough to cover pandemic-driven loan losses. Allowances for loan losses made up 1.0% of total loans at the end of December. In comparison, net loan charge-offs made up just 0.05% of average loans in 2020, according to details given in the 10-K filing.

Further, the credit risk appears to be at a low level. Loans requiring payment deferrals made up only 0.6% of total loans at the end of last year, as mentioned in the earnings release. As a result, I'm expecting the slight increase in loan growth to be the chief driver of provision expense this year. Overall, I'm expecting Penns Woods to report a provision expense of $2.6 million in 2021, down 1% from last year.

Normalization of Non-Interest Income to Drag Earnings

Penns Woods's non-interest income was elevated last year due to high gains on sales of loans. The company reported gains of $4.1 million in 2020 as opposed to $1.8 million in 2019. I'm expecting these gains to return to a normal level this year because stable interest rates will dampen mortgage banking activity. The Mortgage Bankers Association expects mortgage volumes to decline by 17% year over year in 2021.

On the other hand, the slight growth in the loan portfolio will likely drive earnings. Further, the provision expense will likely decline from last year, which will support the bottom line. Meanwhile, the net interest margin will likely remain stable from the fourth quarter of 2020. Overall, I'm expecting the company to report earnings of $2.06 per share, down 5% from last year. The following table shows my income statement estimates.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and new variants. Further, there is uncertainty regarding the tax rate. For the estimates above, I have assumed that the government will increase the corporate tax rate to 28% in the second half of the year.

Year-End Target Price Suggests a Limited Upside

Penns Woods is offering an attractive dividend yield of 5.2%, assuming the company maintains its quarterly dividend at the current level of $0.32 per share. Despite the earnings outlook, there is little threat of a dividend cut because the earnings and dividend estimates suggest a payout ratio of 62% for 2021, which is in line with the historical trend.

I'm using the historical price-to-tangible book multiple ("P/TB") to value Penns Woods. The stock has traded at an average P/TB ratio of 1.25 in the past, as shown below.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $21.6 gives a target price of $27.0 for the end of 2021. This price target implies a 9.8% upside from the April 1 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

To support my investment thesis, I'm also using the price-to-earnings multiple ("P/E") to value Penns Woods. The stock has traded at an average P/E ratio of around 11.2x in the past, as shown below.

Multiplying the average P/E multiple with the forecast earnings per share of $2.06 gives a target price of $23.0 for the end of 2021. This price target implies a 6.2% downside from the April 1 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $25.0, which implies a 1.8% upside from the current market price. Adding the forward dividend yield gives a total expected return of 7.1%. As this total expected return is somewhat small, I'm adopting a neutral rating on Penns Woods Bancorp.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.