Laurentian beats the street, but price appreciation may be capped

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Another bank beats the street!

Laurentian Bank of Canada reported second-quarter earnings on Tuesday, beating the street's expectations and also boosting its dividend by 4 per cent.

Fundamentally, the company reported a solid quarter. Commercial loans and B2B Bank mortgages experienced solid double-digit gains, and management continued to exercise prudent control over its expenses.

"In this challenging interest rate environment, we are working to achieve better operational efficiency and maximize operating leverage," said Réjean Robitaille, the bank's president and chief executive officer, in a quarter report to shareholders.

While the operational results reported by Laurentian were solid, industry headwinds such as the low interest rate environment may limit any material stock price appreciation.

Shares of Laurentian Bank are inexpensive and the yield is very attractive. However, if you are seeking double-digit returns, you may have to look outside of the banking sector, at least in the near-term.

The bank reported earnings of $1.38 per share, above the consensus estimate of $1.28, and the reported earnings of $1.29 reported last year. Revenue growth was moderate at 1.7 per cent year over year. Net interest margin ticked up 1 basis point from last quarter to 1.83 per cent but down from 1.93 per cent last year.

Adjusted ROE (return on common shareholders' equity) was 12.1 per cent. Drilling down to the segmented earnings and looking at the companies three main divisions, Laurentian Personal and Commercial Banking reported adjusted net income of $32.2-million, climbing 6.3 per cent from $30.2-million during the same period last year. Fee growth was strong, growing 5.4 per cent, mainly because of higher mutual fund commissions and higher lending fees due to increased underwriting activity on the commercial side.

The B2B Bank segment remains a challenge. Revenue dropped 4.4 per cent from $52.5-million last year to $50.2-million this quarter, and adjusted net income came in at $11.3-million, declining 16.4 per cent from $13.5-million last year. Management attributes these declines largely to lower levels of brokered deposits. As well, investment loans continued to decline as people continue to focus on reducing their debts.

Laurentian Bank Securities and Capital Market's reported solid results. Revenues increased 8.7 per cent to $19.1-million compared with $17.6-million in the second quarter of 2014. Management said this gain was due largely to higher underwriting fees in the fixed income market and higher trading revenues. Expenses growth was just 3.2 per cent this quarter. Net income jumped to $4.1-million, up from $2.5-million, due to a lower income taxes.

As expected by the street, management increased its quarterly dividend by 4 per cent or $0.02 per share to $0.56. The payout ratio in the second quarter was 39.2 per cent, just below management's targeted dividend payout ratio range of 40 per cent to 50 per cent.

Given the company's healthy balance sheet and financial position, I would anticipate management to continue to make steady dividend increases over time. Laurentian Bank has the most attractive yields compared to the big banks. The yield is 4.6 per cent.

Loan growth remains positive at 3.2 per cent. Residential mortgages grew 3 per cent, commercial mortgages climbed 13 per cent, and commercial lending rose 17.8 per cent. Offsetting this was a 6.3-per-cent decline in personal lending.

On a valuation basis, the stock is currently trading at 8.9 times the 2015 consensus earnings estimate and at 8.4 times the 2016 consensus earnings estimate. The stock's valuation has basically flatlined over the past few years, the multiple has been unable to expand. Until investors see a material improvement in fundamentals that is expected to persist, this stock is likely to remain a "value trap" and range bound. (See the chart below)

Technically, I believe the stock is likely to continue to consolidate.

For nearly the past four years, Laurentian Bank's stock price has been trading principally, in the $40 to $50 range. Technically, the stock looks like it will remain stuck in this trading range. There is downside support at $48, near the 50-day moving average, and at $47, $45, and $43. There is upside resistance at $48.50, near its 200-day moving average, $50, and $51.50, near its previous high set in December 2014. Average daily trading volumes have been declining and are light.

The bottom line is banks have been delivering lacklustre returns year-to-date, underperforming the S&P/TSX Composite Index. Basically, this is not a sector that has delivered strong performance so far in 2015, and I do not believe it is a sector that investors need to be invested in at this point in time.