More Comments RBC Dominion Securities analyst Darko Mihelic sees Bank of Montreal’s (
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$20.9-billion acquisition of San Francisco-based Bank of the West as a “bod deployment of capital,” leading him to raise his rating for its shares to “outperform” from “sector perform” on Tuesday.
“With the acquisition of Bank of the West, BMO will add 1.8 million new customers and US$108-billion of assets to their U.S. footprint. Bank of the West’s loan mix complements BMO’s existing portfolio and provides a solid base to work from with expanded footprint in the Western and Midwestern parts of the U.S.,” he said. “We always viewed BMO as a good commercial bank, but a mediocre bank at best in retail. We believe Bank of the West improves BMO’s consumer business, as the acquisition will add a stronger retail portfolio with respect to deposits, though we believe retail lending may still be somewhat of a gap for BMO. For the consumer business, the acquisition will increase the mix of other consumer loans in categories such as: personal lines of credit, credit cards, autos, marine, and recreational vehicles. On the commercial side, Bank of the West will add additional expertise in the food and agriculture business and provide further diversification with expertise in technology and a decent leasing business.”
In a research report titled Boldly growing, where no Canadian bank has grown before..., Mr. Mihelic said he was “positive on BMO and can’t help but think that TD (rated Sector Perform) may have missed out on a good opportunity given TD’s substantially higher level of excess capital and larger scale U.S. operations. Such impactful deals in the U.S. are hard to come by and this was clearly an auction.”
The analyst expects the deal to be immediately accretive to BMO’s 2023 core earnings per share, prompting him to raise his full-year 2022 projection to $13.94 from $13.30 and his 2023 forecast to $14.57 from $13.84.
“Our model now reflects the operations of Bank of the West starting in Q2/23 and other acquisition-related impacts,” said Mr. Mihelic. “Arguably, BMO deserves a higher valuation multiple for bold and solid actions like this, but we think a rerating needs proof of execution.”
“We see three primary risks. 1) Of all the large banks we cover, it seems that BMO has recently been the most aggressive with cost control, so it is natural to fret that further core investments for future growth may suffer as BMO tries to build capital to pay for this deal; 2) Targeting a CET 1 ratio so close to the minimum ratio may cause discomfort should an unforeseen negative event occur between now and closing; 3) Regulatory uncertainty in the U.S. may cause issues.”
Mr. Mihelic did warn that BMO shares might be “challenged” in the near term, noting: “There are a lot of moving parts between now and closing that some investors might fret over (e.g., capital build, regulatory uncertainty, etc.). However, assuming that the transaction goes according to plan, we find the deal compelling both strategically and financially.”
He raised his target for BMO shares to $160 from $154. The average on the Street is $153.69, according to Refinitiv data.
Conversely, Scotia Capital’s Meny Grauman downgraded BMO to “sector perform” from “sector outperform” with a $162 target.
“As Yogi Berra famously said, ‘When you get to a fork in the road, take it,’” he said. “Heading into the new year most investors would have been content with seeing BMO forego M&A and continue to focus on execution including further ROE and NIX ratio improvements supplemented by above average share buybacks. Instead, what we got was something more complicated, a $21-billion acquisition of a US regional bank that transforms BMO into a major player in California’s competitive banking market and effectively doubles its US branch footprint. The financial metrics of this deal are hard to argue with, including an IRR of 14 per cent and immediate and material EPS accretion, but the strategic rationale for this deal is somewhat more ambiguous. The allure of the California market is undeniable, and we have no doubt that BMO will be a more engaged owner than BNP, but it will likely take a few years before we can judge the true merits of this deal. Over the next few quarters though, the stock is likely to face some headwinds at least until the market can get more clarity on just how big an equity raise will be needed to close this transaction. We do not believe that the path BMO took is a bad one, but it is certainly messier than the alternative.”
CIBC World Markets analyst Paul Holden downgraded the bank to “neutral” from “outperformer” with a $145 target, falling from $157.