This Canadian bank stock is going cheap - and for good reason

Laurentian Bank of Canada is a cheap stock. And it will likely stay that way.

If you buy into management’s spin, the bank is nearing the end of a costly restructuring that has been weighing on its financial results for the past few years.

The Montreal-based lender, Canada’s seventh-largest bank, has completed fraught labour contract negotiations, it has revamped its traditional branches into advice-only “financial clinics” and it has introduced new technology to improve online banking.

Management expects to complete the “heavy lifting” – a term that executives used more than once in a conference call with analysts to describe the transformation – next year, making the bank more profitable and efficient.

The medium-term targets are enticing. By 2022, Laurentian Bank expects to narrow its return on equity gap with bigger banks by 2.5 percentage points. It expects that its efficiency ratio, which compares expenses with profits (lower is better), will fall below 63 per cent from 72.3 per cent today.

As for the bottom line, the bank believes that its adjusted earnings will rise between 5 per cent and 10 per cent annually, reversing the current shrinking trend. For the 2019 fiscal year ended Oct. 31, net income fell 23 per cent compared with 2018.

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 per cent. What’s more, its price-to-book valuation implies a 48 per cent discount relative to the shares of the Big Six banks, according to Canaccord Genuity.

The 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.

“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,” Sumit Malhotra, an analyst at Bank of Nova Scotia, said in a note.

Laurentian Bank’s share price is up 14.6 per cent this year, outperforming Royal Bank of Canada, Toronto-Dominion Bank, Bank of Montreal and Canadian Imperial Bank of Commerce.

But the rally follows a severe 40-per-cent 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 dearth of encouraging upbeat developments.

In the bank’s fiscal fourth-quarter financial results, released on Wednesday, quarterly net income fell 19 per cent, year over year, revenue fell 7 per cent, the mortgage and personal loan book shrank and the efficiency ratio deteriorated. Return on equity was just 7.9 per cent, compared with an average of 15 per cent for the Big Six.

These dismal results – much worse than the generally disappointing earnings season for the biggest banks – come at a time when the bank should be performing well given the strong economic performance of Quebec, its home province and the base of its retail banking operations. National Bank of Canada, also based in Quebec, is this year’s shining star among Canada’s biggest banks: Its shares are up 29.2 per cent.

The Street is bearish. There are no “buy” recommendations 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: 6.8 per cent of the bank’s outstanding shares are sold short, according to Bloomberg, compared with an average of 2.6 per cent for the Big Six.

Given the poor sentiment toward the stock, bargain hunters might see considerable upside should Laurentian Bank’s fortunes start to improve. One key hope: The bank resolved its labour conflict with unionized employees in March, and stability should spur growth in mortgages and personal loans.

But the bigger, more diversified Big Six look like a safer bet until Laurentian Bank can prove that its stock no longer deserves to be cheap.

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