Company Profile

Bank of Montreal (TSX: BMO) is the eighth largest bank in North America in terms of assets and serves more than 12 million customers. BMO offers a broad range of personal and commercial banking and wealth management services. Moreover, it also provides investment banking products and services. BMO conducts business through three operating groups including Personal and Commercial Banking, BMO Wealth Management and BMO Capital Markets. The group’s majority of revenue comes from the Canadian market operations. In the year 2019, the bank’s 31.05% of the revenue comes from the Canadian Personal & Commercial Banking segment, 29.7% from the Wealth Management segment, 20.87% from U.S Personal & Commercial Banking segment and 18.36% from Capital Market segment.

Investment Rationale

• An Income Play: BMO has a track record of consistent dividend payment over the past five years. As on May 27, 2020, the bank has declared a quarterly dividend of CAD 1.06 per share. The dividend distribution remained unchanged on a sequential basis, while increased 3% against the year-over period. Further, the company is offering a lucrative dividend yield of 5.6%, which is approximately 9.03 times higher against the Canada 10 Year Benchmark Bond Yield of 0.62% and 1.51 times of the S&P/TSX 60 average dividend yield of 3.73%. However, the yield is a bit inflated because of the recent plunge in the stock’s price on a YTD basis, though the share price has recovered in lower double-digit in a month over period.

• Higher provisioning reflects a safety-first approach: Due to the challenging macro environment, the bank created provisioning of CAD 1,118 million in the current quarter against the CAD 176 million in pcp. The group has opted the safety-first approach during the quarter and made a provision of CAD 705 million on performing loans. Though the higher provisioning has taken a toll on the profitability, it is likely to provide a cushion against the future setbacks if non-performing assets rise.

• Strong Balance Sheet with solid CET1 ratio: At the end of Q2FY20, the bank reported Common Equity Tier 1 (CET1) ratio stood at 11.0%. The ratio declined 40 basis points on a sequential basis, largely on account of the loan growth. The Liquidity Coverage Ratio (LCR) of the group improved significantly to 147% from 135% in the previous quarter.

• MACD and RSI momentum indicators reflect a potential upside: At the last closing price of CAD 76.07, shares of BMO traded above its crucial short-term support levels of 5-day, 10-day, 20-day, 30-day and 50-day moving averages, which reflects a favourable trend in the stock. Further, the Moving Average Convergence Divergence (MACD) is rising, with a positive spread between 12-day and 26-day exponential moving averages, a positive trend. Also, the moving averages are enhancing, which makes the trend stronger. The 14-day and 9-day Relative Strength Index of the stock hovering above-normal territory and edging higher, therefore technical needle are moving in favour of the BMO, and potential upside is there. 

Financial Highlights: Q2FY20

BMO's performance in the Q2FY20 was moderate, given the economic turmoil because of the COVID-19 pandemic. The group's balance sheet remained strong with CET1 ratio stood firm at 11.0%, higher than the minimum requirement set by the regulator. The bank's net revenue for Q2FY20 declined to CAD 5,461 million against CAD 5,652 million reported in the year over the period, owing to a challenging market condition. The decline was primarily driven by lower revenue from the market sensitive businesses, partly offset by a revenue increase in the P&C business segment.  Further, the bank's non-interest expense declined ~2% to CAD 3,516 million against CAD 3,595 million reported in the previous corresponding period. The bank reported a net income of CAD 689 million as compared to CAD 1,497 million reported in the year-ago period. The steep decline in net income was mainly driven by higher provisions made by the bank for credit losses. The group made a provision of CAD 1,118 million in the current quarter against the CAD 176 million reported in the previous corresponding period. The Liquidity Coverage Ratio (LCR) of the group improved significantly to 147% from 135% in the previous quarter. In Q2FY20, the BMO was selected as the asset manager for the Bank of Canada's Provincial Bond Purchase Program and joint lead manager for World Bank US$8 billion sustainable development bond issue

• Canadian Personal & Commercial Banking: The segment reported a revenue growth amid the challenging environment. Revenue stood at CAD 1,960 million, marking a growth 2.5% over the previous corresponding period. The segment’s pre-provisioning earnings increased to CAD 984 million from CAD 970 million recorded in Q2FY19. Provisioning expenses increased to CAD 497 million from CAD 130 million in pcp. Consequently, net income declined to CAD 361 million during the quarter. The group made provisioning of CAD 285 million on performing loans. Average loans recorded a growth of 7% during the quarter driven by commercial loans, while average deposits grew 15% on an annual basis. 

• U.S. Personal & Commercial Banking: Revenue from the segment increased 6% to CAD 1,046 million against CAD 989 million reported in a year-over period. This was largely driven by a 13% growth in average loans on annual basis. Pre provisioning income increased to CAD 454 million from CAD 407 million in pcp. Provisioning expense increased to CAD 143 million from CAD 17 million; as a result, net income declined to CAD 246 million from CAD 305 million. 

• BMO Capital Markets: Revenue slumped by 15% on a YoY basis to CAD 1,051 million driven by a 22% decline in global market revenue. The segment reported a net loss of CAD 74 million against a net profit of CAD 250 million in pcp. 

• BMO Wealth Management: Net revenue slumped by 15%, driven by 6% reduction in the traditional wealth mainly because of legal provisions. Net income declined to CAD 144 million from CAD 305 million in pcp. Assets under Management remained flat at CAD 865 billion.

Stock Performance

At the time of writing (on June 8, 2020 before the market close), shares of BMO are trading ~1.5% higher at CAD 77.26. In  the year-over period, BMO shares have tested a 52W high of GBX 104.75 (as on January 22, 2020) and a 52W Low of CAD 55.76 (as on March 23, 2020) and at the last traded level, the stock was approximately 36% above its 52W bottom level and approximately 27% below its 52W high price level.

1-year price chart (as on June 8, 2020, before the market close). Source: Refinitiv, Thomson Reuters

Further, in a month over period, shares of BMO recorded an increase of ~ 12.3% and outperformed the benchmark index, which reflects a relative strength in the stock. Also, after the recent recovery in the past few weeks, its shares are now hovering above its crucial short-term support levels of 20-day and 50-day simple moving averages, which is a positive trend in the stock. However, on a YTD basis, BMO shares are featuring a negative price return of 25% and down 24% on a YoY basis and underperforming the benchmark index. The stocks 5-years average Beta stood at 1.02, which implies that the movements in the BMO stocks are more or less similar with the benchmark TSX 300 Composite Index.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 84.52% of the total shareholding. The Vanguard Group, Inc. and RBC Wealth Management, International holds the maximum interests in the company at 3.09% and 2.92%, respectively.

Source: Refinitiv, Thomson Reuters

Valuation Methodology

Note: All forecasted figures have been taken from Thomson Reuters.

Stock Recommendation

Despite a moderate financial quarter, the bank’s balance sheet is strong enough to sustain comfortably against any blow. The group is performing well in personal and commercial banking segment both in Canada and in the United States. The bank has a decent CET-1 ratio of 11%, and Liquidity Coverage ratio of 147%, which reflects the balance sheet strength of the bank. Lower interest rate environment is likely to help the bank in expanding the loan book, while it would put pressure on the net interest margin. The group made higher provisioning during the quarter, which is likely to provide a cushion in case of any asset turned bad. We expect the performance of the capital market segment to improve as the equity market is showing signs of strength. Also, its shares are trading at a relatively discounted valuation in terms of the LTM P/BV against the peer’s average P/BV ratio. BMO’s LTM P/BV ratio stood at 0.88x, whereas peer’s average stood at 1.35x, which reflects a discount of 35% against the peer average. Further, the technical is moving favourable in the stocks, with rising MACD and a positive spread between 12-day and 26-day EMA. The stock is trading well above the short-term crucial support levels of 5-day, 10-day, 20-day and 50-day SMA. Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Buy” recommendation at the current price of CAD 77.26 (as on June 8, 2020) with a lower double-digit upside potential. We have considered Bank of Nova Scotia (TSX: BNS), Toronto-Dominion Bank (TSX: TD) and National Bank of Canada (TSX: NA) etc. as a peer group.

Disclaimer

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