Laurentian Bank of Canada (TSX: LB) is a cheap stock and it will likely stay that way.
Taking a look into the company’s narrative, the bank is approaching the end of an expensive restructuringthat has been a massive weight on its financial results over the past few years. Based out of Montréal, this lender is Canada’s seventh-largest bank and has a history of labour contract negotiations. LB has revamped its traditional branches into advice-only “financial clinics”and it has also introduced some new technology to improve online banking in an effort to keep up the pace with the country’s “big six” major banks.
The bad news:
In the bank’s fiscal Q4 2019 financial results, released in early December 2019, quarterly net income fell 19%year over year. Revenue fell 7%, the mortgage and personal loan book shrank, while the efficiency ratio also depleted. Return on equity was just 7.9%, compared with an average of 15% for the big six.
President and Chief Executive Officer, François Desjardins commented on the results -
“Transformation continues, but the heavy lifting is coming to an end. As we look forward, 2020 will be the year when we complete major initiatives and focus on growth so that we are well-positioned to achieve our medium-term objectives. 2020 will also set the stage for 2021 - our 175th anniversary - and the beginning of a new era for LBCFG.”
“Heavy lifting” was a term that executives used more than once in a conference call with analysts to describe the transformation, which management expects to complete next year, intending to become more profitable and efficient.
These dreary results – much worse than the generally disappointing earnings seasonfor the biggest banks – come at a time when the bank should be performing well, given the strong economic performance of Québec, its home province and the base of its retail banking operations. National Bank of Canada (TSX: NA) , also based in Québec, is this year’s shining star among Canada’s biggest banks. Its shares are up 29.2%.
As for Laurentian’s outlook, the medium-term targets are enticing. By 2022, the expectation is that the return on the equity gap with bigger banks will be narrowed by 2.5 percentage points. It also expects that its efficiency ratio, which compares expenses with profits (the lower the better), will fall below 63% from the current 72%. As for the bottom line, Laurentian believes that its adjusted earnings will rise between 5% - 10% annually, reversing the current shrinking trend. For the 2019 fiscal year ended Oct. 31, net income fell 23% compared with 2018.
So why put a spotlight on LB’s shares?
These targets suggest that Laurentian Bank’s stock is a bargain right now.
It trades at just 10.3 times trailing earnings and has a dividend yield of 6.1%. What’s more, its price-to-book valuation implies a 48% discountrelative to the shares of the big six banks, according to Canaccord Genuity.
But there is a problem. Observers aren’t exactly embracing Laurentian Bank’s targets, given that management has already pushed back the date for various improvements by a year and they’ve demurred on any near-term progress reports. Bank of Nova Scotia (TSX: BNS) analyst Sumit Malhotra stated in a note that - “Our repeated mantra with respect to Laurentian Bank over the past two years has been that the stock cannot work until there is some semblance of stability in earnings power; this is clearly not yet the case.”
Laurentian Bank’s share price is up 14.6% this year, outperforming Royal Bank of Canada (TSX: RY) , Toronto-Dominion Bank (TSX: TD) , Bank of Montreal (TSX: BMO) and Canadian Imperial Bank of Commerce (TSX: CM) .
However this rally follows a severe 40% downturn between 2017 and 2018, which had driven Laurentian’s share price toward 10-year lows. This year’s gains may be more of a bounce than an indication of a sustainable trend, given the shortage of encouraging upbeat developments.
The Street is bearish without a single “buy” recommendation among the 11 analysts covering Laurentian Bank, but four “sell” recommendations and seven “holds,” according to Bloomberg.
Laurentian Bank is also a popular target among short-sellers, who profit when share prices fall. Bloomberg also reported that nearly 7% of the bank’s outstanding shares are sold short, compared with an average of 2.6% for the big six banks.
Given the poor sentiment toward the stock, bargain hunters might see considerable upside should Laurentian Bank’s fortunes start to improve.
There is still one key hope:
The bank resolved its labour conflict with unionized employeesin March, and stability should spur growth in mortgages and personal loans.
But the bigger, more diversified big six could still be a safer bet until Laurentian Bank can prove that its stock no longer deserves to be cheap.