CIBC’s biggest challenge: closing the valuation gap

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Canadian Imperial Bank of Commerce has been saddled with a curiously low stock valuation for years, frustrating investors who feel the bank should trade in line with its Big Six peers. Good news: CIBC’s strong performance during the coronavirus pandemic may at last rescue the stock from the bargain bin.

Bank stocks, as a group, are hardly priced to perfection, given that they are exposed to this year’s weak economic activity, high unemployment and the prospect of surging loan defaults. On average, the Big Six trade at 11.5 times reported profits, according to Bloomberg.

But CIBC trades at just 10.9 times its reported profits, trailing its peers. And what’s key here is that the bank’s valuation has been lagging its rivals for well over a decade.

The reason: CIBC has a history of making costly mistakes that have eroded confidence in the bank’s performance.

It lost big on telecom debt after the dot-com bubble burst in 2000. In 2004, it agreed to pay US$2.4-billion to settle a class-action lawsuit tied to the Enron accounting scandal. And huge writedowns on U.S. debt during the financial crisis sent the bank deep into the red in 2008, a dubious distinction among its peers.

CIBC earned an unflattering epithet from an analyst: the bank “most likely to walk into a sharp object.”

Investors have been on the lookout for the next pointy stick. Could it come from a downturn in the Canadian housing market, where CIBC is particularly exposed? How about further expansion into the United States, with a high-priced deal?

And what about the pandemic? If a Canadian bank was going to be skewered by the economic disaster caused by COVID-19, surely CIBC would be that bank.

But this is where investors should consider that CIBC just may be a better bank today, and one that is worthy of a higher valuation.

The bank’s third-quarter financial results for the quarter ended July 31, released last week, buttress this upbeat view. Profit rebounded 199 per cent from the previous quarter and beat analysts’ expectations. Return on equity, a measure of profitability, rebounded to a healthy 12.1 per cent. Its common equity Tier 1 capital ratio, a financial buffer, rose to 11.8 per cent, also beating estimates.

As for bad loans, total provisions for credit losses declined by nearly 63 per cent from the previous quarter.

In short, no sharp objects here.

“We see nothing in third-quarter results that changes our mind on the strength of CIBC’s balance sheet or on credit quality relative to peers,” Darko Mihelic, an analyst at RBC Dominion Securities, said in a note.

Mr. Mihelic raised his valuation target for CIBC: He now expects that the stock will trade at 10 times his forecast 2021 earnings per share, up from a previous valuation multiple of 8.5.

Gabriel Dechaine, an analyst at National Bank Financial, expects that the stock will trade at 10.5 times his estimated earnings, up from a previous valuation multiple of 10.

Based on reported profits, CIBC’s valuation is already a smidgen higher than Bank of Nova Scotia’s.

However, there are still a few obstacles standing between the old, accident-prone CIBC and visions of a newer, more co-ordinated one.

For one thing, CIBC could improve its timing.

It bought Chicago-based PrivateBancorp Inc. in 2017 for US$5-billion, at a time when U.S. regional bank stocks were hot and some analysts were concerned that CIBC was overpaying. The KBW Regional Banking Index has declined 35 per cent this year and is back to 2013 levels.

As well, CIBC is set to unveil the first stage of its splashy new Toronto headquarters later this year, at a time when remote work has raised questions about the future of offices.

More importantly, analysts caution that the end of government financial support and the expiration of loan deferral payment programs leaves some uncertainty ahead for all banks – CIBC included. If the bank gets it right, though, a rising valuation will provide a nice lift that investors have long been hoping for.

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