The Bank of Montreal (BMO, Financial) has gained around 44% over the last year, while none of the other Canadian banks have gained more than 29%. The company has simply outperformed its peer group.
This growth has been powered by strong quarterly results, including the most recent quarter.
And yet, the stock trades with a reasonable valuation, one that is lower than what has been typical of shares over the long term.
Let’s look closer at the company to see why I feel that the Bank of Montreal can still move higher.
A rundown of earnings highlights
The Bank of Montreal reported fourth-quarter and fiscal year 2021 results on Dec. 3. For the quarter, revenue grew nearly 11% to $5.1 billion, though this was $86 million lower than what Wall Street analysts had anticipated. (All figures in U.S. dollars unless noted and reflect the average U.S. dollar to Canadian dollar exchange for the period in question.) Adjusted earnings per share of $2.59 was well ahead of adjusted earnings per share of $1.86 in the prior year.
For the year, revenue grew 21% to $21.7 billion while adjusted earnings per share of $10.33 compared favorably to adjusted earnings per share of $5.95.
Across the company, average net loans were up 3%, primarily driven by a 9% increase in residential and personal loans. Average customer deposits improved 7%.
Canadian Personal & Commercial Banking revenue grew more than 13% due to gains made in non-interest income while adjusted net income was up 42% due to a recovery of credit losses. This segment had a recovery of credit losses of $4 million compared to provisions for credit losses of $75 million quarter over quarter and $152 million year over year. Average loans were up 8% from the prior year, led by proprietary mortgages and commercial loans. Average deposits gained 7%.
U.S. Personal & Commercial Banking revenue grew more than 9%, with adjusted net income surging 63%. Adjusted net income growth was mostly due to a recovery of credit losses of $24 million compared to a PCL of $135 million a year ago. Non-interest revenue and income were higher by 18% and 7%, respectively, due to growth in most categories. Average loans were up 3%, with commercial higher by 4% and personal flat. Deposits increased 7%.
BMO Wealth Management had revenue growth of 17% and adjusted net income climbed 14%, driven by traditional wealth benefiting from gains in client assets and double-digit growth in deposits. Assets under management increased 8% and assets under administration improved 4%.
Revenue for BMO Capital Markets was up 4%, while adjusted net income was up 40%. Recovery of credit losses totaled $70 million compared to PCL of $51 million a year ago. Top-line growth was due to higher investment and corporate banking revenue as advisory and underwriting business were in high demand.
Takeaways
The Bank of Montreal had another stellar quarter. Revenue missed estimates, but was still up a double-digit percentage from last year. Earnings per share gains, fueled in part by a recovery of credit losses, was up considerably from last year. This isn’t the whole story as loan and deposit growth was solid overall and the capital markets business saw robust equity market activity.
The net interest margin excluding trading was 1.66%, down 1 basis point from the third quarter of the year, but higher by 6 basis points from the previous year. However, most of the Canadian banks have reported an expectation that interest rates will begin to rise in the upcoming calendar year, with the Federal Reserve expected to raise rates at least twice in 2022. Other central banks may follow suit, giving a lift to net interest income and margin.
Non-interest income was higher by low double-digits, as nearly every business showed year-over-year gains. Strength was particularly pronounced in mutual funds, investment management and underwriting and advisory businesses.
Bank of Montreal’s U.S. business, which represents 38% of the bank’s earnings, continues to perform well. In 2018, leadership set an ambitious goal to have the U.S. business contribute a third of earnings overall, so the company is ahead of its expectations. The U.S. business contributed 50% of earnings to the BMO Capital Markets during the quarter. And in the states that company operates, which includes Illinois, Kansas and Wisconsin, Bank of Montreal has the number three deposit market share.
Bank of Montreal also raised its dividend. U.S. investors will always need to be mindful of the impact of currency translation payments, but domestic shareholders will collect $1.04 of dividends on Feb. 28, 2022. This represents a 25% increase from the dividend received during the first quarter of last fiscal year. Shares yield 3.8% on an annualized basis, nearly three times the average yield of the S&P 500 Index.
Valuation analysis
According to Wall Street analysts surveyed by Seeking Alpha, the Bank of Montreal is expected to earn $10.29 per share in fiscal year 2022. This is a slight decline from last fiscal year’s result, but would be the Bank of Montreal’s second-best result ever. Shares of the company trade at 10.6 times forward estimates.
The stock has traded in a fairly tight valuation range over various periods of time. Shares have an average price-earnings ratio of 11.6 and 11.2 over the last five- and 10-year periods of time.
I believe a valuation range of 10 to 12 times earnings is appropriate for the Bank of Montreal as this takes into account the stock’s historical average and reflects the company’s strong recent performance.
Applying fiscal 2022 estimates to my valuation target results in a price target range of $103 to $123.50. With the stock presently trading at $109, returns could range from a decline of 5.5% to a gain of 13.3%.
Factor in the company’s dividend and the total downside could be marginal total returns could reach into a mid-double-digit percentage.
Final thoughts
The Bank of Montreal has been the best-acting stock among the Canadian banks over the last 12 months. Strong results have driven this gain. The company’s recent quarter was another example of how well Bank of Montreal has performed as it recovers nicely from the pandemic.
The ongoing recovery of credit losses continues to be a positive sign, showing the company’s loan book is in a good position. Non-interest income did well and net interest income should see tailwinds of a very much expected rate hikes next year.
Even with all of this working for Bank of Montreal, the stock trades below its medium- and long-term average price-earnings ratios. Reaching the top end of my valuation range, which isn’t too far off the historical averages, would result in an additional low double-digit gain from the current share price. The dividend, which just received a massive raise, remains attractive.
The company’s recent quarterly result coupled with potential total returns suggests that Bank of Montreal presents a very good risk-reward proposition at the current price.
