Unlike its U.S.-based counterparts, most of the large Canadian financial institutions were not forced to cut their dividends during the financial crisis. Many of the Canadian banks did pause dividend growth during this period, but most returned to increasing dividends very shortly thereafter. The Canadian banks' ability to maintain dividends in the last recession is evidence that they are well managed.
Canada’s largest banks are also also offering 5%-plus dividend yields at the moment, with many trading with a single-digit price-earnings ratio. A high yield, low valuation is often a value investor’s dream scenario.
As such, we will explore why Canadian Imperial Bank of Commerce CM might be one of the best investments in the entire banking industry.
Company background and recent earnings results
With a market capitalization of just over $27 billion, Canadian Imperial is the fifth-largest bank in Canada. It was formed through a 1961 merger between Canadian Bank of Commerce, which was founded in 1867, and the Imperial Bank of Canada, which was founded in 1873. The bank operates several reported segments, including Personal and Small business, Commercial Banking and Wealth Management and Capital Markets.
While Canadian Imperial is focused on Canada primarily, the bank does have operations in nearly 20 countries around the world. Slightly more than half of the bank’s loan book is comprised of residential mortgages, while business and government account for a third of loans and personal and credit card loans make up the remainder.
Canadian Imperial reported first-quarter 2020 earnings results on Feb. 26. The bank earned $2.43 per share, which was 17 cents higher than analysts had predicted and 6% above results for the previous year. Revenue improved 4.5% to $3.7 billion, topping expectations by $51 million.
Canadian Personal and Small Business Banking net income dropped 2% as spending on initiatives, like infrastructure and technology, more than offset increases in volumes and margins. Deposits balances were up 6% and net interest margins climbed 9% from first-quarter 2019 and flat from fourth-quarter 2019. As a result of higher expenses, Canadian Imperial’s efficiency rating, a measure of what it costs the bank to generate a $1 of revenue, increased 160 basis points to 52.3%. On the bright side, provisions for credit losses declined 16% for this segment.
Canadian Commercial Banking and Wealth Management had net income growth of 7%. Commercial loans deposits were up 14%, while commercial loan balances increased 9%. Net interest margins of 3.22% were down eight basis points from the previous year, but up 14 basis points from the most recent quarter. Non-interest income was strong, up 10% due to double-digit growth in assets under management and assets under administration as well as higher net sales.
Net income for U.S. Commercial Banking and Wealth Management increased 6%. This segment had a 22% increase in deposit balances and loan balances were up 18%. Net interest margins were down 29 basis points to 3.02% year over year, but this shouldn’t be surprising as interest rates were lower in the most recent quarter. Assets under management had 20% growth. Canadian Imperial is spending capital to help build its infrastructure and technology in the U.S. as the company hopes to improve its market share in the region.
Broad-based improvements in trading, financing, underwriting and lending led to 63% growth in net income for Capital Markets. Trading and financing were solid across the board, led by 41% revenue growth in the U.S.
Wrapping up the quarter, the adjusted return on equity was higher by 10 basis points to 16.1% and impaired loans totaled just 0.47% of total loans. Provisions for credit losses dropped more than 20% year over year.
Overall, Canadian Imperial had a solid first quarter to the fiscal year. Net income improved in most divisions. Where net income was lower from the previous year, it was primarily due to capital expenditures to help grow the business. Net interest margins will be lower going forward, but the bank is seeing solid deposit growth as well as improvements in loans and assets under management.
Growth prospects and potential headwinds
Behind several peers in its U.S. presence, Canadian Imperial is attempting to make up ground on the competition. The bank has expanded into the U.S. and now has operations in many states, including California, New York and Texas.
As a result, the U.S. has begun to play a much larger role in the bank’s business. Nearly 20% of adjusted earnings in the first quarter of fiscal 2020 come from the region, up from just 8.7% in fiscal 2017. Assets under management have improved more than 17% over this same period of time as well.
Canadian Imperial has also embraced technology. Active mobile users have seen a healthy growth rate of 28% to 2.9 million from fiscal 2018. Nearly 70% of customers now perform banking activities digitally. This is a 5.5% increase from just two years ago. Active self-service transactions reached almost 90% in the latest quarter.
There are headwinds for the bank though. First off, the appearance of Covid-19 in North America and stay at home orders that have been in place in an effort to slow the spread of the virus have had a true impact on the economy.
Non-essential workers in many U.S. states and Canadian provinces have been asked or required to stay home. This has caused disruptions in the economy as fewer people spend money than they normally would. This has led to many businesses of all sizes struggling to keep workers on payrolls.
Canadian Imperial, along with the other large banks, are working with clients. Assistance includes six-month payment deferrals for mortgages and credit card payments. The bank said it is seeing around 20,000 deferral requests from consumers and small businesses each day. The deferral payments will impact results for Canadian Imperial along with the rest of the sector.
A second issue is the collapse in oil prices that occurred in early March as OPEC+ members disagreed on production cuts. This spooked investors as many U.S. and Canadian energy companies would find it difficult to survive with very low oil prices for a lengthy period of time. Financial institutions with exposure to this industry could find themselves holding loans to bankrupt companies. Fortunately, it appears that a deal has been made to remove nearly 10 million barrels per day of oil. This is the largest output cut in history. Even if energy prices don’t recover to their previous levels, Canadian Imperial should be protected as a little more than just 2% of its loan portfolio was directly tied to oil and gas as of the end of fiscal year 2019.
Canadian Imperial does face some headwinds, especially due to the economic impact of Covid-19, but expansion into the U.S. and an embrace of technology is a long-term winner for the bank. This will help the bank continue to pay a generous dividend.
Dividend and valuation analysis
Canadian Imperial has a long history of paying dividends, having paid its first in 1868, just a few years after the conclusion of the U.S. Civil War. The bank did pause its dividend growth in both 2009 and 2010, but has increased it in Canadian dollars every year since then. The average annual increase is near 5% over the last decade.
U.S. investors have seen an annual increase of just 2.3% from 2010 to 2019. Part of this can be explained due to currency exchange rates. Even so, dividends to these investors have increased in seven out of the last 10 years.
What Canadian Imperial lacks in dividend growth it makes up for in dividend safety and yield. Analysts expect $7.92 of earnings per share for the current fiscal year. Using current exchange rates, U.S. investors should receive $4.20 in dividends per share in fiscal 2020, which equates to payout ratio of 53%. This is slightly above the 10-year average payout ratio of 47%, but still solidly in a safe range.
The bank’s free cash flow payout ratio looks even better. In U.S. dollars, Canadian Imperial distributed $1.8 billion in dividends last year while generating $9.5 billion in free cash flow for a payout ratio of 19%. The bank averaged a 25% payout ratio over the previous three years.
Canadian Imperial offers a yield of 6.8% today. This is not only the highest yield among the major Canadian banks, it is one of the highest yields in the entire banking industry. While high yields can often be a sign of trouble, the bank's dividend should be considered safe due to its payout ratios.
Canadian Imperial is also very cheap. While the bank, along with the rest of the sector, are experiencing some headwinds, earnings estimates for the current year have already come down. Most analysts who cover Canadian Imperial have already brought down numbers so some of the issues facing the bank are likely already baked into estimates.
Shares of the bank trade at $61.62 on the New York Stock Exchange. Using fiscal year 2019 results of $9.04 in earnings per share and estimates for the current year, shares of Canadian Imperial trade with a trailing price-earnings ratio of 6.8 and a forward price-earnings ratio of 7.8. The stock has averaged a multiple of 10.2 times earnings over the last 10 years, which is below that of most peers.
If the stock were to trade in a price-earnings range of 8 to 10, then shares are worth $63 to $78 using forward numbers. Inside of this range would result in capital gains of almost 27% at the high end. Add in a nearly 7% dividend yield and you have the makings of an excellent total return for just a slight increase in valuation.
Final thoughts
Canadian Imperial’s most recent quarter was solid, with growth occurring in most areas of the business. Covid-19 will undoubtedly have a significant impact on most areas of the economy, but Canadian Imperial has made strategic investments in order to grow. Expansion in the U.S. and investing in technology will put the bank in a strong position once the virus has subsided.
The company offers a very high yield that is well protected by both earnings and free cash flow. The bank has also paid a dividend every year since 1868. While year-over-year increases haven’t always been assured, the bank’s commitment to distributing dividends to shareholders is very much engrained in it’s DNA.
Finally, investors don’t appear to expect much from the bank as it’s price-earnings ratio is below its historical average and that of its peers. Any positive uptick in the business could lead to a recalculation of what shares are worth. This, plus the dividend, make for an excellent possible total return. I rate shares of Canadian Imperial as a buy.
Disclosure: The author is not long Canadian Imperial.
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