Time To 'Buy' More Bank of Montreal

Summary

• Banks, like many stocks, have been selling off steeply in the last few sessions of the stock market due to inflation and recession fears.
• However, banks will most certainly benefit from a rising interest rate environment. Most financials will. That is why I am adding to financials.
• BMO has dropped from above its average P/E valuation and now trades at a clear discount. Results show relatively less worries for the bank.
• Here is why I'm at a "BUY" for BMO.
• Looking for more investing ideas like this one? Get them exclusively at iREIT on Alpha. Learn More »

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I've written a few times about the Bank of Montreal (NYSE:BMO), one of the interesting, large Canadian banks. This is a bank that offers good yield, good security, and excellent overall returns.

We do want to look at valuation prior to investing, to make sure we're not overpaying for the bank, but the usual range of valuation and price that this bank moves between is fairly narrow. That makes it, at least theoretically, somewhat predictable as an investment.

Let's look at what BMO can offer us in terms of upside and returns.

Bank of Montreal - Revisiting the company and its results

Ending 2021 well, the company has since reported the initial period of 2022. This period came in at appealing levels, seeing good income, EPS, Efficiency, RoE, and fundamentals, including retaining a 14%+ CET1-ratio.

BMO announced the M&A of the Bank of the West, and every single bank segment reported good performance, despite overall market conditions and geopolitical macro.

Bank of Montreal 1Q22 Results (BMO IR)

BMO has strong operations In the US - stronger than some American banks, with operations across the Midwest, the western coast, Texas, Florida, and others. These segments posted very promising results, and the bank is now #11 in commercial lending with a #3 deposit market share in core footprints, such as Chicago and Milwaukee. Growth is also strong here, and over 50% of the company's revenue comes from areas that are outside of the overall core footprint of the company's businesses.

The M&A will accelerate NA growth, and the bank has already filed for regulatory approval, with expectations of $670M worth of cost synergies on a pre-tax basis.

The company's fundamentals remain extremely strong. An over 200-year history started back in 1817, and the 8th-largest bank in NA in terms of assets, serving 12 million customers on an annual basis means that this is one of the more significant Canadian banks to invest in. My stance towards the banks - BMO, Scotiabank (BNS), and CIBC (CM) as well as others is positive. I own shares in all of them, and I buy more when valuation allows for this.

Overall, very little in terms of the positives have changed when it comes to Bank of Montreal. The M&A of BoTW adds a FV impact to the company's balance sheet but calculating these can be somewhat tricky given their relative sensitivity to overall interest rates. This will also impact the amount of goodwill, and therefore company capital. Higher interest rates mean higher goodwill due to lower fair value of the fixed-rate assets, which will increase BMO's capital requirements. I believe it fair to say that we're not going into a lower rate environment, meaning that the FV for the bank will be around $12B, implying a $2.7B equity raise on the part of BMO.

Still, customer deposits are showing encouraging increases, with customers increasing their pace as rates go up, up almost $40B YoY. The company's NIM and NII will obviously also increase as a result of raised interest rates, with a 1% rate increase implying a $540M pre-tax increase in income.

Impaired loans are back to near pre-pandemic levels.

BMO Impaired loans (BMO IR)

And the overall loan portfolio looks very good, with 45% consumer loans spread between mortgages, cards, and personal loans, and 55% government/business loans, with only very marginal (1%) exposures to Oil & Gas. The highest exposures here are financials, service industries, real estate, manufacturing, and other relatively conservative sectors.

Are there any significant risks to BMO here?

Not really. The main questions are regarding the positive impacts and effects of increasing rates, and how such changes affect the capital markets. There are also some questions regarding how quickly or how effectively the company is coming along with its tech projects - the bank responding that investments in tech and sales force will continue.

Supply chain issues are also translating into issues in the loan growth side/the loan portfolio. Despite these issues though, BMO is seeing significant loan growth, with much of the loan growth in the USA actually related to new business.

However, on a high level, it would be incorrect to characterize BMO as a bank that faces any sort of serious risks or pressures. It's simply a bank in the current environment, which comes with its own set of headwinds and risks - but none really specific to BMO.

I continue to believe in the company as a valuation case - and this makes valuation for BMO crucial. Here are the current trends for the company insofar as valuations go.

Company valuation

We're moving into an environment where valuations for quality are (finally) going to be falling again. This provides us with buying opportunities of the highest order, both during and following a potential crash.

BMO is certainly attractive here. The company typically trades at average valuations of between 9.5-11X P/E, with a current P/E of 10X. Based on the exact 5-year average of 10.84X, this implies a slight upside to 2022E, and a larger upside to 2024E, based on significant forecasted EPS growth on the back of increased business volume and positive rate trends.

F.A.S.T graphs BMO Upside (F.A.S.T Graphs)

As you can see, the upside is significantly higher than just 7-9% annually at this point in time. This is an A+ rated bank with a 3%+ yield. It is one of the lower yields in the Canadian banking sector, but it's also one of the safer banks in terms of portfolio diversification, US market exposure and expected earnings growth during the next few years, as well as the historical accuracy of these growth numbers.

This might not be the most exciting companies to invest in. I admit that. 10-16% annually, you might ask - that's not that much, is it?

Well, compared to some things, it probably isn't, no. But going into an inflationary hell, some would argue stagflationary environment, your portfolio needs safe bets.

Bank of Montreal is a safe bet.

BMO isn't going anywhere. This Is a safe, covered, yield backed by an essential banking oligopoly in one of the safest nations on earth.

For the US-listed BMO ticker, analysts are forecasting a range of between $145 to $175 per share, coming to an average of $160/share, implying an upside of around 50% here. I would view this far more conservatively, coming in at around $140/share in the longer term. Even to this more conservative price target, however, the upside is well over 20% - even over 30%.

To my mind, BMO will perform as expected, and this will cause your portfolio to at least perform in line with market expectations, growing 10-16% annually. It also has the capacity to outperform more, coming to 20-22% annually, if things go to historical highs.

But it usually doesn't go far beyond this - not historically.

So, BMO is a safe bet. These are the sort of safe bets that we currently need and want. Because, as I'm watching the market go up and down, this is a pretty scary market we're currently in.

I consider BMO a "BUY" with a $140/share price for the NYSE-listed ticker BMO on the basis of a 2024E forecast.

Thesis

My thesis for BMO is as follows:

• The bank is a great company/organization with fundamental safeties that have performed extremely well during the pandemic and has incredible recovery tailwinds, which are currently playing out and are likely to continue to do so.
• Investors in BMO can count on long-term safety for their invested capital, coupled with fair returns with a yield of around 3.2% today.
• The upside inclusive of capital appreciation is now more than 15% on a conservative basis. I consider this company to be a "BUY" with a $140/share PT.

The bank also fulfills every last one of my investment criteria.

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has realistic upside based on earnings growth or multiple expansion/reversion.

Based on such trends, current earnings, and forecasted EPS growth of 55% in 2022, I consider BMO a "BUY" with an upside of at least 10-18% this year, potentially more in a 3-year period.

Thank you for reading.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BMO, BNS, CM either through stock ownership, options, or other derivatives. 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.

While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved. I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles. I own the Canadian tickers of all Canadian stocks i write about. Please note that investing in European/Non-US stocks comes with withholding tax risks specific to the company's domicile as well as your personal situation. Investors should always consult a tax professional as to the overall impact of dividend witholding taxes and ways to mitigate these.