Fulton Financial: Acquisition Benefits, Organic Growth To Lift Earnings

Aug. 05, 2022 4:11 AM ETFulton Financial Corporation (FULT)
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Sheen Bay Research
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Summary

  • The recent acquisition of Prudential Bancorp will boost the loan book size and lead to material cost savings.
  • Robust commercial loan pipelines and team expansion plans bode well for organic loan growth.
  • The rising interest-rate environment will lift the margin but at the same time reduce the equity book value per share, which will hurt valuation.
  • The December 2022 target price suggests a significant upside from the current market price. Further, FULT is offering a high dividend yield for a bank holding company.
Fulton Bank front

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The recent acquisition of Prudential Bancorp will boost the earnings of Fulton Financial Corporation (NASDAQ:FULT) through the end of 2023. Further, earnings will benefit from continued organic loan growth. On the other hand, higher provisioning expenses will likely drag earnings. Overall, I'm expecting Fulton Financial to report earnings of around $1.68 per share for 2022, up 3% year-over-year. For 2023, I'm expecting the company to report earnings of $1.79 per share. The year-end target price suggests a high upside from the current market price. Therefore, I'm upgrading Fulton Financial to a buy rating.

Acquisition to be an Important Catalyst for Earnings Through 2023

Fulton Financial completed the acquisition of Prudential Bancorp on July 1, 2022, as recently announced. The acquisition expanded Fulton's presence in Pennsylvania, according to details given in the merger presentation. Further, the acquisition added loans totaling around $594 million, resulting in a 3% boost to Fulton's loan portfolio.

However, the biggest benefit from the acquisition will be the cost savings. The management expects to save 45% of Prudential's operating expenses following the merger, with around 80% phased in this year and 100% thereafter.

On the other hand, the acquisition will likely lower the net interest margin. As mentioned in the presentation, Prudential had a margin of 2.32% in the fourth quarter of 2021, which was much below Fulton's margin of 2.77%. Further, the acquisition will have a dilution effect as Fulton has issued around 6 million shares to Prudential Bancorp’s shareholders.

Outlook on Organic Loan Growth is also Bright

The loan portfolio surged by 2.4% in the second quarter of 2022, or 9.7% annualized, which is the highest quarterly loan growth since the second quarter of 2020. The management appeared optimistic about commercial loan growth in the latest conference call. According to the management, the pipelines have remained strong, which will support growth in the segment in the near term. Further, the management intends to expand the commercial loan team.

Moreover, line utilization is likely to improve, which will boost the outstanding loan balances. As mentioned in the conference call, the management is foreseeing the excess liquidity of businesses to dry up, which it believes will lower deposits but also improve the line of credit utilization.

However, the outlook for consumer loan growth is not that bright. Higher interest rates are likely to hurt this segment the most as individual borrowers will likely put off borrowing until a time when rates are lower. The Federal Reserve projects rates to start declining from next year.

Overall, I'm expecting the loan portfolio to grow by 9.5% in 2022. Loan growth will likely return to the usual mid-single-digit range for 2023 in the absence of another M&A transaction.

Meanwhile, the rising interest-rate environment will compress equity book value per share. This is because higher rates will reduce the value of fixed-rate securities, thereby increasing the accumulated unrealized loss on securities, which will flow directly to the equity account bypassing the income statement. The following table shows my balance sheet estimates.

FY18 FY19 FY20 FY21 FY22E FY23E
Financial Position
Net Loans 16,004 16,674 18,623 18,076 19,802 20,606
Growth of Net Loans 2.6% 4.2% 11.7% (2.9)% 9.5% 4.1%
Other Earning Assets 3,056 3,291 5,244 5,728 4,747 4,940
Deposits 16,376 17,394 20,839 21,573 22,423 23,334
Borrowings and Sub-Debt 1,747 1,765 1,926 1,038 1,064 1,108
Common equity 2,248 2,342 2,424 2,520 2,402 2,582
Book Value Per Share ($) 12.7 14.0 14.9 15.4 14.3 15.3
Tangible BVPS ($) 9.7 10.8 11.6 12.1 11.1 12.1

Source: SEC Filings, Author's Estimates

(In USD million unless otherwise specified)

Unlike BVPS, Margin to Benefit from a Rising-Rate Environment

The management expects its loan book to be much more rate-sensitive than the deposit book. As mentioned in the conference call, the management estimates its deposit beta to be around 15% to 20%, and the loan beta to be much higher at above 40%.

The management's interest-rate sensitivity analysis given in the first quarter’s 10-Q filing showed that a 200-basis points hike in interest rates could boost the net interest income by 11.4% over twelve months. However, this analysis assumes a rate shock. As the interest rate hike this year has been more of a gradual ramp, the effect of the hike on net interest income will be much lower than 11.4%.

Overall, I'm expecting the net interest margin to improve by 30 basis points in the last two quarters of 2022 from 3.04% in the second quarter of the year. This estimate includes the impact of the Prudential acquisition. Further, I'm expecting the margin to remain stable in 2023 mostly due to the interest rate outlook. I'm expecting the Federal Reserve to increase the Fed Funds rate further in the remainder of the year before cutting it by mid-2023.

Provisioning to be Slightly Above Normal in the Second Half of 2022

Allowances were 143% of nonperforming loans at the end of June 2022, down from 166% at the end of June 2021, according to details given in the earnings presentation. Therefore, I believe Fulton Financial will have to increase its provisioning in the year ahead. High interest rates and the possibility of a recession are likely to pressurize the portfolio’s asset quality, which will require higher provisioning in the remainder of the year. Overall, I'm expecting the net provision expense to average 0.20% annualized in the last two quarters of 2022 and all four quarters of 2023. In comparison, the net provision expense averaged 0.19% of total loans in the last five years.

Expecting Slight Earnings Growth

Benefits from the acquisition and organic loan growth will likely play a pivotal role in boosting earnings this year and the next. On the other hand, higher provision expenses will likely drag earnings in 2022. Further, merger-related expenses will drag earnings this year before tapering off. However, cost savings from the Prudential acquisition will curb non-interest expenses through 2023.

Overall, I'm expecting Fulton Financial to report earnings of $1.68 per share for 2022, up 3% year-over-year. In 2023, I'm expecting earnings to grow by 7% to $1.79 per share. The following table shows my income statement estimates.

FY18 FY19 FY20 FY21 FY22E FY23E
Income Statement
Net interest income 630 648 629 664 744 841
Provision for loan losses 47 33 77 (15) 15 40
Non-interest income 196 216 229 274 230 235
Non-interest expense 546 568 579 618 617 634
Net income - Common Sh. 208 226 176 265 277 301
EPS - Diluted ($) 1.18 1.35 1.08 1.62 1.68 1.79

Source: SEC Filings, Earnings Releases, Author's Estimates

(In USD million unless otherwise specified)

Compared to my last report on Fulton financial, I've significantly increased my earnings estimate for 2022. This is because Fulton has announced the acquisition of Prudential Bancorp since the issuance of that last report. Further, the economic outlook has changed significantly since that report.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.

Upgrading to a Buy Rating

Given the earnings outlook, I’m expecting Fulton Financial to increase its dividend per share by $0.01 in the first quarter of 2023 to $0.16. Fulton Financial also usually announces a special dividend in the last quarter of the year, which I’m expecting to be maintained at $0.08 per share. My dividend and earnings estimates suggest a payout ratio of 40% for 2023, which is close to the last four-year average of 44%. Therefore, I believe my expectation is reasonable. The dividend estimate for 2022 suggests a dividend yield of 4.2% and the estimate for 2023 suggests a dividend yield of 4.4% (including the special dividend).

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Fulton Financial. The stock has traded at an average P/TB ratio of 1.42 in the past, as shown below.

FY18 FY19 FY20 FY21 Average
T. Book Value per Share ($) 9.7 10.8 11.6 12.1
Average Market Price ($) 17.4 16.5 12.0 16.1
Historical P/TB 1.79x 1.53x 1.03x 1.33x 1.42x
Source: Company Financials, Yahoo Finance, Author's Estimates

Multiplying the average P/TB multiple with the forecast tangible book value per share of $11.1 gives a target price of $15.7 for the end of 2022. This price target implies a 3.7% downside from the August 4 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple 1.32x 1.37x 1.42x 1.47x 1.52x
TBVPS - Dec 2022 ($) 11.1 11.1 11.1 11.1 11.1
Target Price ($) 14.6 15.2 15.7 16.3 16.8
Market Price ($) 16.4 16.4 16.4 16.4 16.4
Upside/(Downside) (10.5)% (7.1)% (3.7)% (0.3)% 3.1%
Source: Author's Estimates

The stock has traded at an average P/E ratio of around 12.0x in the past, as shown below.

FY18 FY19 FY20 FY21 Average
Earnings per Share ($) 1.18 1.35 1.08 1.62
Average Market Price ($) 17.4 16.5 12.0 16.1
Historical P/E 14.7x 12.2x 11.1x 9.9x 12.0x
Source: Company Financials, Yahoo Finance, Author's Estimates

Multiplying the average P/E multiple with the forecast earnings per share of $1.68 gives a target price of $20.1 for the end of 2022. This price target implies a 22.9% upside from the August 4 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

P/E Multiple 10.0x 11.0x 12.0x 13.0x 14.0x
EPS 2022 ($) 1.68 1.68 1.68 1.68 1.68
Target Price ($) 16.7 18.4 20.1 21.8 23.4
Market Price ($) 16.4 16.4 16.4 16.4 16.4
Upside/(Downside) 2.4% 12.7% 22.9% 33.2% 43.4%
Source: Author's Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $17.9, which implies a 9.6% upside from the current market price. Adding the dividend yield gives a total expected return of 13.8%.

In my last report, I adopted a target price of $17.7 on Fulton Financial. At the time of the issuance of that report, the market price was slightly higher than the target price; therefore, I adopted a hold rating. Since then, the market price has plunged, leaving a decent upside to the year-end target price. Therefore, I'm now upgrading Fulton Financial Corporation to a buy rating.

This article was written by

Sheen Bay Research profile picture
2.71K Followers
Around 10 years of experience covering Banks and Macroeconomics. Passionate about discovering lucrative investments and generating alpha.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Additional disclosure: 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.

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