Earnings of Commerce Bancshares, Inc. (NASDAQ: NASDAQ:CBSH) will likely decline downwards in the next three quarters compared to the first quarter of 2021. After a significant reversal of provisions in the first quarter, I'm expecting no further big releases because the loan deferrals have increased, and exposure to pandemic-sensitive segments is moderately high. Additionally, I'm expecting the net interest margin to face pressure from the low-interest-rate environment and sticky deposit cost.
On the other hand, the loan portfolio will likely continue to grow, albeit at a low rate due to the upcoming forgiveness of Paycheck Protection Program loans. Overall, I'm expecting the company to report average quarterly earnings of $0.89 per share in the last three quarters of 2021, down from $1.11 per share in the first quarter. For the full year, I’m expecting the company to report earnings of $3.80 per share, up 31% year-over-year. The year-end target price suggests a downside from the current market price. Based on the valuation analysis and earnings outlook, I'm adopting a neutral rating on Commerce Bancshares.
Commerce Bancshares has reversed some of its provisions for loan losses in the last two consecutive quarters. I'm not expecting further big reversals because of the following factors.
The above factors are discussed in further detail below.
As mentioned in the first quarter's investor presentation, net charge-offs made up 0.25% of average loans in the first quarter of 2021. In comparison, allowances made up 1.22% of total loans at the end of March. As a result, the net charge-offs appear to be relatively high.
Further, loans requiring payment deferrals have recently increased. As mentioned in the presentation, loan deferrals made up 0.9% of total loans at the end of March 2021, up from 0.6% of total loans at the end of December 2020. Moreover, Commerce Bancshares has relatively high exposure to COVID-19 sensitive industries, including hotels and retail. As mentioned in the presentation, these vulnerable industries made up 9.1% of total loans at the end of March 2021. Further, consumer credit card loans made up 4% of total loans at the end of the last quarter. The following table from the presentation shows the exposure to vulnerable industries.
Considering the factors mentioned above, I'm expecting the company to report an average provision expense of $20 million in the last three quarters of 2021, taking the full year’s provision expense to $54 million. In comparison, Commerce Bancshares reported a provision expense of $137 million in 2020.
The loan portfolio will likely continue to grow in the remainder of the year due to the vaccine-driven economic recovery throughout the country. However, I'm expecting the loan growth to remain low by historical standards, mostly because of the upcoming forgiveness of Paycheck Protection Program (“PPP”) loans. As mentioned in the presentation, Commerce Bancshares had $1.5 billion worth of round 1 PPP loans outstanding at the end of last quarter.
I'm expecting most of this balance to get forgiven in the first half of 2021. Meanwhile, participation in the second round has remained comparatively lukewarm. As mentioned in the presentation, Commerce Bancshares has approved PPP loans totaling only $331.4 million in the second round of PPP this year.
Considering these factors, I'm expecting the loan portfolio to increase by 1.5% by the end of December from the end of March. For full-year 2021, I'm expecting the loan portfolio to increase by 2.0% year-over-year. I'm expecting other balance sheet items to grow more or less in tandem with loans in the year ahead. The following table shows my estimates for loans and other balance sheet items.
The average portfolio yield will likely come under pressure in the year ahead as loans will get repriced down in a low-interest-rate environment. Moreover, Commerce Bancshares’ deposit cost has limited room to decline. As mentioned in the first quarter's earnings release, the average rate on interest-bearing deposits equaled only 0.09% in the first quarter of 2021. Additionally, rates on certificates of deposits equaled 0.37% for smaller denomination certificates and 0.35% for larger denomination certificates. Therefore, there is limited room for deposit costs to decline in the year ahead.
Considering the pressure on average portfolio yield and the stickiness of deposit cost, I'm expecting the net interest margin to decline by six basis points in the last three quarters of 2021. This will take the average net interest margin in 2021 to be 39 basis points below the average margin for 2020.
I'm expecting the earnings in the last three quarters of 2021 to be below the earnings for the first quarter because of higher provision expense. Further, pressure on the net interest margin will likely reduce the net income for the last three quarters. On the other hand, subdued loan growth will likely support the bottom line. Overall, I'm expecting the company to report earnings of $0.89 per share on average for the last three quarters of 2021, down from $1.11 per share in the first quarter of 2021.
Overall for 2021, I’m expecting the company to report earnings of $3.80 per share, up 31% year-over-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.
Commerce Bancshares is offering a dividend yield of 1.3%, assuming the company maintains its quarterly dividend at the current level of $0.2625 per share. The earnings and dividend estimates suggest a payout ratio of 27.7% for 2021, which is close to the five-year average of 32%. Hence, I’m not expecting the company to increase its dividend this year.
I’m using the historical price- to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Commerce Bancshares. The stock has traded at an average P/TB ratio of 2.30 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $29.0 gives a target price of $66.6 for the end of 2021. This price target implies a 14.5% downside from the April 27 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has traded at an average P/E ratio of around 17.7x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $3.80 gives a target price of $67.1 for the end of 2021. This price target implies a 13.9% downside from the April 27 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 $66.9, which implies a 14.2% downside from the current market price. Adding the forward dividend yield gives a total expected return of negative 12.9%.
The company’s earnings will likely trend downwards in the year ahead from the first quarter’s level because of higher provision expense. For the full year, however, Commerce Bancshares’ earnings will likely be much higher than last year due to a dip in the provision expense. Because of the anticipated earnings surge for 2021, I believe a bearish rating will be inappropriate for Commerce Bancshares despite the price downside. As a result, I’m adopting a neutral rating on the stock.
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