Event
BMO reported core EPS of $1.16, after adjusting reported cash EPS of $1.25 for a significantly lower Q2/06 tax rate (23.5% versus a more normalized level of 30.0%). This result was below our estimate of $1.19 and consensus of $1.21, and down from $1.24 in Q1/06, but up from $1.09 a year ago. The quarterly dividend was increased 17% to $0.62 per share, and the payout ratio to 45-55%.
Impact
Negative. We are increasing our 2006 EPS estimate to $4.90 (from $4.85) to reflect a lower tax rate, but reducing our 2007 EPS estimate to $5.05 (from $5.15). We are also lowering our 12-month target price to $66.00 (from $72.00), but maintaining our HOLD recommendation on the stock.
Details
Total retail banking results were weak, with cash earnings of $294 million, down from $308 million in Q1/06 and $302 million in Q2/05. We have meaningfully reduced our earnings projections for this operation. P&C Canada results were lackluster, with the division reporting cash net income of $261 million, down from $269 million last quarter (partly due to fewer days in the quarter), and down from $265 million a year ago. Solid asset growth, (average assets increased 9% year over year to $114 billion) was offset by margin compression, with net interest margins declining 6 bps sequentially to 2.52%, and down from 2.64% a year ago. Margin pressure reflected aggressive loan pricing, particularly in mortgages, in an attempt to defend declining market share.
P&C Chicagoland results were also weak, with cash net income of US$28 million down 20% sequentially and 7% year over year. The decline was driven by higher expenses to upgrade the branch technology platform, and higher origination and marketing expenses.
The investment banking group was clearly the outperformer during Q2, reporting cash net income of $245 million (closer to $217 million after adjusting for the unusually low tax rate), versus $229 million in Q1/06 and $173 million in Q2/05. Trading was a key driver of the improvement year over year. Total trading revenues were $179 million, down from $231 million in Q1/06 but up from $131 million a year ago reflecting favourable trading conditions and increased client activity in energy markets.
Wealth management results were reasonable, with the group reporting cash net income of $98 million, up slightly from $95 million in Q1/06 and $87 million a year ago. Sequentially, results reflected higher revenues in full service and direct investing. While a reasonable result, we were somewhat disappointed that earnings were not stronger, given RRSP season, and that assets under management fell.
Credit performance was still solid, with the bank’s PCL ratio increasing slightly to 0.14%, from 0.12% last quarter and 0.11% a year ago, however the increase in PCL’s does create an earnings headwind. Impaired loan formations also increased to $173 million, up from $78 million last quarter, and the highest level since Q2/04, which may indicate an end to the unsustainably low levels reported in recent years.
Tier 1 capital was 10.2% versus 10.4% last quarter, and management repurchased approximately 1.9 million.
Valuation
Trading at 12.2 times 2007 earnings versus a peer group average of 11.6 times 2007 earnings, and given our reduced 2007 earnings estimates, particularly given the lack of any clear catalyst for future growth, we believe BMO is fairly valued at current prices and are maintaining our HOLD recommendation.
Justification of Target Price
Our $66.00 target price is a product of adding 90% of our fundamental target price to 10% of our acquisition value. Our fundamental target price of $60.25 is calculated by adding 50% of the $58.55 value derived from our 2007 P/E valuation of 11.6 times, to 50% of the $61.96 value derived from our 2007 price-to-book valuation of 1.99 times. Our acquisition model derives a BMO acquisition value of $78.75.
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) the Conservative government stating they will not permit mergers and 5) a deterioration in the credit environment.
Investment Conclusion
We are unconvinced of the direction of BMO, and are concerned that relative to the other Canadian banks that earnings growth will be modest. Over a period of 2-3 years, the bank engaged in a significant cost-reduction strategy (150 bps per year reduction in the efficiency ratio was the mantra), that led to solid EPS growth, despite concurrent market share losses in the ever important Canadian domestic bank.
We believe that with the cutting done, the bank finds itself in a difficult competitive position - branches and ATMs need upgrading, more marketing spend is required, etc. We speculate that the initial trigger reaction was to cut rates to stem the bleeding, but with margins having been hurt so badly, the bank finds itself in a very difficult position.
In our opinion, a strategy to resolve the issue was not articulated. The increase in the quarterly dividend and the dividend payout ratio were eye-catching, but we do not believe the fundamentals of the bank support such a move. We have reduced our valuation multiples to reflect what we consider to be BMO’s difficult situation.
We expect the other banks in the group to report stronger results, and believe the shares of the group to be oversold.
The Globe and Mail, Sinclair Stewart, 25 May 2006
Bank of Montreal surprised investors yesterday by committing to pay out as much as 55 per cent of its annual profit in dividends, a sign of just how desperate Canadian banks have become to rid themselves of their excess capital -- and an indication of just how few places there are to spend it.
BMO announced its second major dividend increase in as many quarters, pledging to boost its quarterly payment to 62 cents a share from 53 cents, representing a 26-per-cent jump since the fourth-quarter of last year.
More importantly, though, the bank raised its dividend payout target from between 35 and 45 per cent of profit to between 45 and 55, the highest among the country's Big Five banks.
Canadian banks are notoriously cautious about toying with this range, since an aggressive increase can handcuff their ability to make future acquisitions or reinvest in their existing businesses.
Robert Wessel, an analyst with National Bank Financial, said he was surprised by BMO's dividend commitment, since it could have strategic implications for the bank when it is preparing for succession. Chief executive officer Tony Comper is expected to step down early next year and pass the reins to chief operating officer Bill Downe.
"It's extremely large and the timing is quite unusual given that there's going to be a change in CEO in the short term," Mr. Wessel said. "For better or for worse, we find it hard to imagine it doesn't limit the bank's flexibility going forward with respect to longer-term acquisition plans."
The dividend announcement overshadowed BMO's second-quarter financial results.
But it was not enough to keep the bank's stock from sliding a penny to $61.50 on what some analysts described as a weak performance.
The bank reported a profit of $636-million or $1.24 a share, a 7-per-cent improvement that was driven by stronger investment banking and wealth management results, better trading revenue, and a lower tax rate. BMO's cash profit of $1.25 a share did manage to beat consensus estimates of $1.21, but some observers suggested the number was inflated by the favourable tax rate.
The bank's flagship retail operation, however, continued to show problems, partly because of price-cutting on products like mortgages, which has undermined profit margins.
The retail bank's profit of $286-million has now slid for three successive quarters, and is at its lowest level since the end of 2004. BMO's head of retail, Rob Pearce, resigned abruptly earlier this month, and the division will be run temporarily by Mr. Downe, who told analysts during a conference call yesterday he was "optimistic" it will be able to deliver better performance.
Mr. Downe also insisted that BMO has sufficient capital on hand to continue with the bank's U.S. acquisition strategy and at the same time provide investors with a juicier dividend yield.
All of the banks have been coping with the problem of excess capital, which has only been exacerbated by declining provisions for loan losses over the past couple of years.
"Frankly, I think Canadian banks are sitting on more excess capital than any other banks in the world," chief financial officer Karen Maidment said during the call.
Ms. Maidment said the altered dividend policy has not changed the bank's plans or appetite for acquisitions.
BMO has repeatedly said it would entertain purchases of as much as $2-billion (U.S.), but yesterday bank officials emphasized they are focusing more on small to medium-sized deals in the Chicago market, where its Harris Bank subsidiary is based.
Some analysts believe the dividend payout increase is a sign BMO doesn't see anything on the horizon.
"It would seem to me that opportunities for acquisitions in the Midwest may be limited," said Mario Mendonca, an analyst with Genuity Capital Markets. "It may reflect management's perspective that acquisitions aren't in the cards, at least in the short term."
Mr. Wessel predicted the dividend move could slow the growth rate of excess capital to virtually nothing, especially now that loan-loss provisions -- one of the biggest earnings drivers recently in the industry -- begin to creep up again.
Many had expected the banks to begin revisiting their dividend plans after Ottawa announced late last year that it would increase the dividend tax credit, making dividend-paying stocks that much more enticing to investors.
Royal Bank of Canada and Canadian Imperial Bank of Commerce are currently at between 40 and 50 per cent, while Toronto-Dominion Bank and Bank of Nova Scotia (along with BMO, before its announcement) were all at between 35 and 40.
Scotiabank, which is awash in excess capital and has been the stock market laggard among its peers over the last year, is viewed as the most likely to respond with a change to dividend policy.
TD, which has had little trouble finding ways to deploy its cash through U.S. purchases, is viewed as the least likely to follow suit.
| Bank | Dividends Paid (2005) | Dividend Payout Ratio (%) | Targeted Payout Ratio (%) |
| BMO | $925-million | 39 | 45-55 |
| CIBC | $902-million | NM^ | 40-50 |
| RBC | $1.5-billion | 45 | 40-50 |
| Scotiabank | $1.3-billion | 41 | 35-45 |
| TD | $1.1-billion | 38 | 35-45 |
__________________________________________________________
The Globe and Mail, Roma Luciw, 24 May 2006
Bank of Montreal reported a 7.4 per cent profit increase, hiked its dividend and raised its dividend payout ratio to the highest level among the big banks, a move analysts say could pressure its rivals to follow suit.
Early Wednesday, the Toronto-based bank raised its quarterly dividend from the previous quarter by 9 cents, or 17 per cent, to 62 cents a share. It also increased its dividend payout range by 10 per cent to between 45 per cent and 55 per cent of earnings.
"The most significant event in the quarter was the increase in the dividend and more importantly, the increase in that target payout dividend range," said Tom Kersting, an analyst with brokerage Edward Jones in St. Louis. He believes the bank's payout range is now the highest among the large Canadian banks.
"That really shows that BMO is committed to returning capital to shareholders as opposed to potentially investing it in unwise business decisions," he said, adding that he had not supported the bank's decision to pour money into its Harris Bank operations in the United States.
BMO said profit attributable to shareholders climbed to $636-million or $1.24 a share in the three months ended April 30 from $592-million or $1.16 a share a year ago.
On a cash basis, the bank earned $1.25 a share in the second quarter. Analysts polled by Thomson First Call were expecting earnings of 1.21 a share.
Shares of BMO slumped 44 cents or 0.72 per cent to $61.07 after the release of the results on Wednesday. The shares have dropped 5.4 per cent so far this year, making it the worst-performing of the big six bank stocks to date this year, outside of Bank of Nova Scotia.
UBS Securities Canada Inc. analyst Jason Bilodeau said the dividend hike puts pressure on Scotiabank to follow suit.
He said BMO's core banking may be lacking growth momentum. "Management has talked of efforts to invigorate the bank - particularly in domestic personal and commercial - but it is an outstanding issue and is likely to remain so in coming quarters," Mr. Bilodeau said.
BMO's quarterly profit was boosted by its private client group, which reported a 25 per cent rise in earnings to $96-million. The bank's mutual fund business was one of the key drivers of that rise in profit.
The other strong performer was the investment banking arm, where earnings climbed 19 per cent to $245-million.
"Investment banking group earned record net income and private client group's results were its second-best ever, surpassed only by the final quarter of last year when we recorded significant gains on sales,” BMO chief executive officer Tony Comper said in a statement.
A rise in stock trading volumes, merger advisory fees, stock and debt underwriting and mutual fund sales all contributed to the quarter's gains, offsetting slowing profit in consumer banking.
BMO's personal and commercial banking operations saw its profit slide 2.4 per cent to $286-million. The bank's corporate support group also reported lower profit of $17-million, a drop of $7-million.
BMO is the first of the large Canadian banks to report its second-quarter financial results and according to Mr. Kersting, the rest of the bank's results will likely mirror the ones investors saw today.
"We are going to see strong trading results from all of them on the back of equity markets," he said. "On the negative side, competition is high in commercial and retail banking and that is being reflected in the weaker margins."
BMO's return on equity fell to 19.1 per cent from 19.5 per cent a year earlier.
The bank said it took $66-million in provisions against specific loans, above $46-million a year ago and $52-million in the first quarter. That brings the total so far this year to $118-million, up from $89-million a year ago.
BMO said it still expects to book a total of $325-million or less for fiscal 2006.
__________________________________________________________
Reuters, Frank Pingue, 24 May 2006
Bank of Montreal reported a 7 percent jump in second-quarter profit on Wednesday and upped its dividend 17 percent as strength in its investment banking arm offset a decline in its retail banking division.
Canada's fourth-biggest bank, kicking off the banking sector's reporting season, said it had a net profit of C$644 million ($575 million), or C$1.24 a diluted share, for the quarter ended April 30, up from a profit of C$600 million, or $1.16 a share, in the same period last year.
On a cash basis, Bank of Montreal said it earned C$1.25 a share, which beat expectations of C$1.20 a share, according to analysts polled by Reuters Estimates.
Revenue during the quarter rose 3 percent to C$2.5 billion, while return on equity, a key measure of financial performance, was 19.1 percent compared with 19.5 percent last year.
Bank of Montreal recorded a provision for credit losses of C$66 million in the quarter, compared with C$46 million. That brought total provisions for credit losses to C$118 million this year compared with C$89 million last year.
BMO's quarterly earnings were given a lift by its investment banking arm, which posted a 19 percent jump in profit to C$245 million. Earnings at its private client group rose 25 percent to C$96 million.
The personal and commercial banking unit weighed on earnings, however, as profit there dropped 2.4 percent to C$286 million, while profit at BMO's corporate support group dropped 29 percent to C$17 million.
"P&C banking is one of the bigger things to take out of this, which is it wasn't really all that strong and it was down for the third consecutive quarter," said Robert Wessel, an analyst at National Bank Financial.
"That's pretty key ... it's the heart of every Canadian bank and is probably taking on a greater significance in the market than the dividend increase."
Bank of Montreal also said it raised its quarterly dividend by 17 percent, to 62 Canadian cents a share.
