Friday, March 02, 2007

BMO Q1 2007 Earnings

TD Newcrest, 2 March 2007


BMO reported Q1/07 adjusted cash operating EPS of $1.32, ahead of our estimate of $1.30, consensus of $1.29, and $1.24 reported last quarter. Year over year, cash EPS rose 6.5%, the slowest of the group so far. Two of the three operating divisions fell short of our estimates, albeit we would regard the quarter as satisfactory.


Neutral. We are increasing our 2007 EPS estimate slightly to $5.53 (from $5.50) but maintaining our 2008 EPS estimate at $5.85. Also, we are maintaining our 12-month target price of $73.00 and Hold rating on the stock


P&C Domestic results were slightly above our expectations driven by stable net interest margins, strong asset growth, and good expense management. Importantly, the bank managed to curtail market share losses in certain important product categories. However we believe that BMO remains particularly challenged in domestic banking (as reflected by the charge taken in the quarter) and that revenue challenges still exist. We view BMO’s solid results as a product of the strong retail banking environment rather than an indication that issues within the organization have been resolved.

P&C U.S. results were up 21% from Q4/06 but down 14% from Q1/06. The division benefited from growth in personal and commercial loans, but compressed net interest margins and a slowing Midwest economy negatively affected profitability. We remind that Harris Bank represents only about 5% of BMO’s consolidated earnings, but we are disappointed that various projects completed last year are not positively impacting results.

Private Client earnings were slightly below expectations but still solid. Net income was $96 million, up 13% from Q4/06 due to increasing market driven revenue growth. The benefits of this growth were partially offset by higher expenses related to continued investment in the bank’s sales force and U.S. investment management business. Earnings performance from this division fell far short of the growth generated by peers.

Investment banking results were below our expectations, driven by softer than expected trading income related to lower commodity derivatives trading revenues. Exhibit 1 shows that BMO’s trading volatility has been quite high. As well, the bank grew corporate banking assets at a rapid clip in quarter, with average loans and acceptances increasing $5.7 billion or 35% year over year. While BMO mgmt quickly promotes its solid credit history, we worry it is becoming amongst the most aggressive trading banks, and is also now quickly growing its corporate lending book as the US economy slows. These trends seem somewhat out of character.

Credit performance still excellent. The PCL rate was 0.10%, and GIL’s were $748 million, inline with the year ago period. Formations were $113 million, up from $78 million a year ago.

Tier 1 capital was consistent at 9.9% at January 31, 2007, down from 10.2% last quarter mostly due to a surge in risk weighted assets. The bank announced a $0.03 dividend increase to $0.68. BMO offers investors the highest dividend yield of the group, likely providing the stock a firm floor price.

Justification of Target Price

Our $73.00 target price is a product of adding 90% of our fundamental target price to 10% of our acquisition value. Our fundamental target price of $73.30 is calculated by adding 50% of the $74.67 value derived from our 2007 P/E valuation of 13.5 times, to 50% of the $69.04 value derived from our 2007 price-to-book valuation of 2.56 times. Our acquisition model derives a BMO acquisition value of $86.29.

Key Risks to Target Price

We believe that the four key valuation risks specific to BMO that may prevent the stock from attaining our target price are: 1) unfavourable interest rate changes; 2) the competitive environment in the United States constraining Harris Bank’s profitability; 3) the bank making a larger than expected U.S. acquisition at premium valuation multiples; 4) a deterioration in the credit environment.

Investment Conclusion

This was a solid quarter for BMO, but we feel that on a relative basis, they are the weakest of the Canadian banks that have thus far reported Q1/07. We continue to believe that other banks in the space provide much stronger growth potential/fundamentals than BMO. That said, we believe BMO shares should be supported by investor demand for safety and yield in 2007. It remains Hold rated with a $73.00 target price.
Financial Post, Duncan Mavin, 2 March 2007

Measures to slash 1,000 jobs at Bank of Montreal are needed to foster growth and avoid "inertia and decline" at the bank, said BMO's new chief executive yesterday.

"[The restructuring] will not only take costs out of the business but it will make the business more efficient," said incoming CEO Bill Downe, who formally took over the reins from Tony Comper at the bank's annual meeting in Toronto.

BMO first announced the restructuring charges last month. The measures cost $135-million in the first quarter of 2007, including $117-million of severance costs

BMO's profits for the first quarter fell 3.4% to $585-million compared with $606-million a year ago.

Excluding the one-off charge, profit rose 11%.

Mr. Downe said the measures will enable the bank to better focus on customer service.

BMO made a strong push for a bigger share of the Canadian retail banking market last year, but it was largely deemed to have failed to make much impact.

"Although the Canadian consumer lending environment has enjoyed solid performance recently, BMO has benefited from a smaller piece of this pie [than its rivals,]" said Madhavi Mantha, a banking analyst with research firm Celent LLC.

Management is trying to improve its retail banking offering, said UBS Investment Research analyst Jason Bilodeau.

But, Mr. Bilodeau said, "we need comfort that a positive inflection point in domestic [retail banking] is on the horizon."

Mr. Downe said the bank will make renewed attempts to improve its retail banking performance under his stewardship.

"We think we can raise the bar on customer service," said Mr. Downe, who said he personally spent some time last week in focus groups discussing BMO's retail bank.

The new chief executive revealed that BMO will renovate 30 locations in 2007, and open 15 new branches. The number of BMO mortgage specialists will be increased by 20% this year.

Chief financial officer Karen Maidment said BMO has already begun making the job cuts and expects all the layoffs to come in 2007. The cuts are not expected to affect customer facing staff.

BMO is not disclosing what cost savings it expects to flow through to its bottom line, said Ms. Maidment.

Overall, the bank delivered cash earnings of $1.32 per share, excluding the restructuring charge, compared to an average of analysts' estimates before results were announced of $1.30 per share.

BMO's Canadian retail banking group turned in first-quarter profit that was up $30-million, or 12%, from last year at $292-million. The bank's U.S. retail banking franchise delivered earnings of $29-million, down 14% from the same quarter in 2006. BMO earned $219- million from investment banking, 2% less than in the first quarter last year.
The Globe and Mail, Andrew Willis, 1 March 2007

Bank of Montreal has been losing retail customers to rivals for several years. On Thursday, newly appointed chief executive officer, William Downe, used his first annual meeting to make a tough-love pitch on how to stop the bleeding.

As the new boss graciously took the baton from Tony Comper, CEO for the past seven years, the 54-year-old Mr. Downe pledged that BMO branches will win a larger share of the lucrative retail market.

His call to arms, coming on the heels of 1,000 back office job cuts announced in January, is part of a broader push to build a bigger and more profitable bank.

The simple message from Mr. Downe, who recently spent four hours behind one-way glass listening to branch customers complain, is that BMO must offer better service. “The real key to growth is to provide our customers with a better experience once they walk through our doors,” he said in Toronto.

The front lines of the retail banking wars are in cities such as Kamloops, B.C., where BMO will open a new $2.6-million branch next Thursday that sums up its strategy for winning the hearts and wallets of clients.

The 50-employee branch will feature traditional tellers working shoulder-to-shoulder with small-business bankers, mortgage specialists, stockbrokers and BMO private bankers who typically cater to clients with $1-million-plus portfolios. There will be a drive-through window, and the branch's regular business hours will be extended, with doors also open Saturdays from 10 a.m. to 4 p.m.

In the past year, BMO replaced most of its 1,936 ATMs, and put new signs on many of its 963 domestic branches, featuring the name of both the bank and its wealth management arm, BMO Nesbitt Burns Inc.

The bank plans to open 15 new branches this year, and renovate 30 locations. In an internal talk last month, Mr. Downe told colleagues that banking “is a lot like hockey. You have to hit the competition before they hit you.”

While BMO's Canadian retail division posted a profit of $292-million for its fiscal first quarter ended Jan. 31, up $30-million from the comparable quarter last year, the bank continued to lose market share in areas such as personal deposits, a sector targeted by rivals such as Bank of Nova Scotia.

Over all, BMO reported a profit of $585-million in the quarter, including a $135-million restructuring charge that reflects severance costs, down 4 per cent from the same period a year earlier.

“The quarter suggests that efforts to turn the fortunes of the domestic business are still ongoing. The trends are mixed, not getting materially worse, and management is moving to address the issue,” said UBS Securities Canada Inc. analyst Jason Bilodeau.

Shareholders were quick to offer their input on services that could be fixed. One discount brokerage client, a woman of a certain age, asked the CEO if he could do something about the music when she is put on hold, as “it's all that awful teenage wailing about their lovers.” Mr. Downe promised to both change the music and cut down the wait times.

Retail expansion does not extend to the U.S. market, where BMO forecasts an economic slowdown in the second half of this year. Mr. Downe said the bank will open fewer branches than planned in the Chicago area, where it has 234 outlets, due to weakness in the real estate market that is expected to spill over into other sectors.

Mr. Comper retired Thursday from a bank he joined in the summer of 1967, “a young man with an English degree and a guitar.” During his watch as CEO, annual profit doubled to $2.66-billion, and the bank also had to bounce back from a failed 1998 merger with Royal Bank of Canada. Looking back at the 1999 restructuring of BMO, in his first year at the helm, Mr. Comper said: “I think of the post-non-merger crisis as my finest hour professionally.”

Mr. Comper leaves the bank with $78-million in shares and stock options, and a pension that the banks calculates is worth $26.8-million.
Bloomberg, Doug Alexander, 1 March 2007

Bank of Montreal, Canada's fourth-largest bank, said profit fell for the first time in six quarters after it cut 1,000 jobs to lower costs.

Net income for the period ended Jan. 31 fell 3.5 percent to C$585 million ($499 million), or C$1.13 a share, from C$606 million, or C$1.17 a share, a year earlier, the Toronto-based bank said today in a Canada NewsWire statement. Revenue rose 4.1 percent to C$2.61 billion.

William Downe, who takes over today as chief executive officer, is reducing costs to counter a slump in mortgages and consumer lending. Bank of Montreal had an C$88 million cost in the quarter to cut 1,000 head office and administrative jobs, equal to 3 percent of the workforce.

``The single most important area the bank needs to address to rebuild market credibility is in the domestic personal and commercial business,'' Genuity Capital Markets analyst Mario Mendonca wrote in a research note.

Bank of Montreal shares fell 65 cents to C$70.11 in 4:10 p.m. trading the Toronto Stock Exchange, and have risen 1.6 percent this year.

Bank of Montreal said in November that market share for Canadian personal banking slipped to 12.85 percent last fiscal year from 13.04 percent, after it stopped discounting mortgages to win market share from bigger rivals.

The bank forecast profit growth will slow to between 5 percent and 10 percent this year, from 12 percent in fiscal 2006. The job cuts are the biggest for a Canadian bank since Royal Bank of Canada, the largest lender, cut 1,660 jobs in 2004.

Bank of Montreal raised its quarterly dividend 4.6 percent to 68 cents a share, the second increase in as many quarters.

Investment banking profit fell 2 percent to C$219 million during the quarter. Profit from its private client group, which includes brokerage, investing services and mutual funds, rose 4 percent to C$95 million. Mutual fund sales at the bank fell 6.4 percent to C$645 million in the quarter from C$689 million a year earlier, according to preliminary figures from the Investment Funds Institute of Canada.

Canadian consumer banking profit rose 12 percent to C$292 million and profit from its Chicago-based Harris Bank unit fell 14 percent to C$29 million.

National Bank Financial analyst Robert Wessel, who rates the stock ``sector perform'', said profit was C$1.32 a share excluding one-time items, compared with his estimate of C$1.33 a share on that basis. That matched the C$1.32-a-share median estimate of 10 analysts polled by Bloomberg News.

The bank plans to reduce expenses as a percentage of revenue this year after missing its target in 2006. Non-interest expenses rose to C$6.35 billion last year from C$6.33 billion a year earlier as the bank spent more money on branches.

This was the last earnings report for Anthony Comper, who announced in November he would step down after more than eight years as CEO. Comper, 61, will stay on as an adviser until April 24, when he retires.