Updated on January 28th, 2019 by Josh Arnold
Each year, S&P Global Indices reviews its list of Dividend Aristocrats, a group of companies in the S&P 500 Index with at least 25 consecutive years of dividend increases.
In late January, companies that reached the necessary 25 years are added to the list. There were four additions to the Dividend Aristocrats list in 2019, one of which was People’s United Financial, Inc. (PBCT), a regional bank.
People’s has a strong history of dividend growth, particularly for the highly cyclical financial sector, which saw many of even its largest constituents cut their dividends during the financial crisis. That wasn’t the case for People’s.
People’s not only has an impressive streak of dividends, but a very high current yield as well. At a time when both the S&P 500 and the financial sector both have yields just under 2%, People’s is sporting a 4.2% yield. This article will discuss People’s business model, growth potential, and valuation.
People’s was founded in 1842 in Bridgeport, Connecticut. The bank began operations with just $97 in total deposits and had no paid employees for its first 10 years of operations. In the 177 years since that humble beginning, People’s has grown into a regional bank with more than 5,000 employees and almost 400 retail locations in the Northeast United States.
Today, People’s produces $1.8 billion in annual revenue from its $48 billion in total assets, and the stock has a market capitalization of $6.2 billion.
People’s reported Q4 earnings on 1/17/19 and results were strong, producing another record in earnings-per-share. Adjusted earnings-per-share came in at $0.36, an increase of 16% year-over-year. Operating earnings actually grew 28% in dollar terms but the bank’s higher share count – thanks to shares issued for acquisitions – was much higher and offset some of that growth.
Net interest income grew 14% thanks to 10bps growth in net interest margin to 3.17%, but also acquired and organic revenue growth; noninterest income rose less than 2% during the quarter. Importantly, adjusted noninterest expense rose only 7%, which was much slower than the pace of revenue growth.
As a result, the bank’s efficiency ratio fell 100bps year-over-year, despite acquisition integration expenses, to 55.1%. That is a very respectable efficiency ratio and with People’s focus on cost savings, we expect it will continue to drift lower over time.
Indeed, the above slide shows how People’s efficiency ratio has improved rather drastically just in the past four quarters, declining from 59.4% to 55.1% during 2018. While gains like this aren’t realistic for the long-term, we see People’s ability to fairly rapidly improve its cost structure as a major benefit.
Total loans ended the year 8.5% higher than 2017 and deposits followed suit, gaining 9.4%. People’s loan-to-deposit ratio is very high at 97.4%, but is actually slightly lower than it was at the end of 2017. Most banks tend to stay under 90% and while there isn’t anything inherently wrong with a high loan-to-deposit ratio, it does open the bank up to more exposure to losses.
Essentially, the loan-to deposit ratio is a measure of leverage, and People’s is very high. It also crimps future growth potential simply because there isn’t much more the bank can do to boost it from very high levels, so this is not a lever the bank can pull to boost revenue growth going forward.
Asset quality, however, is outstanding and affords People’s the ability to have nearly all of its deposits lent out. Net charge-offs were just 9bps of all loans in Q4, which is consistent with recent results. Its originated nonperforming loans did tick up to 55bps from 49bps in the year-ago period, but again, these are strong numbers and we aren’t concerned about credit quality.
Return on average assets moved higher in Q4, gaining a whopping 15bps over last year’s Q4 to 1.11%. That’s an average ROA number so People’s isn’t near the top of profitability for banks, but it certainly isn’t near the bottom either. Return on average tangible common equity gained as well, rising 110bps to 14.9% in Q4.
The balance sheet is in good shape, despite the high loan-to-deposit ratio, as People’s tier 1 common equity ratio moved 60bps higher to 10.3% in Q4. Overall, we see People’s as a strong operator with good metrics all around, which is relatively rare for a bank that likes to acquire its growth.
We like People’s performance in 2018 and expect another year of strong growth for 2019. We’re out with an initial estimate of $1.45 in earnings-per-share for this year, representing low double-digit growth over 2018 and another record.
While People’s produces a small amount of organic growth – as just about any other bank would – its strategy instead focuses on acquiring its growth. It has a diversified portfolio of financial services it can offer to customers, but its bread and butter is still core deposit-taking and lending activities.
The bank recently completed the acquisition of First Connecticut Bancorp, an all-stock transaction valued at $544 million. The purchase afforded People’s more than $3 billion in assets, representing high single digit asset growth at the time of the transaction. The transaction has a projected tangible book value earn back period of 3.5 years, which is fairly low. The all-stock, immediately accretive model of acquisitions is one People’s has used over and over again with good success. We have no reason to think the recently-completed First Connecticut purchase will work out any differently.
More recently, the bank announced on 1/17/19 the acquisition of VAR Financial, a Texas-based private leasing and finance company. VAR finances equipment sales for technology manufacturers, software companies and resellers. This non-core banking business will fold in with People’s existing LEAF Commercial Capital subsidiary and help the bank diversify away from core lending activities a bit more.
Finally, People’s announced during the fourth quarter it was acquiring BSB Bancorp in another all-stock transaction valued at $327 million.
As seen in this slide, BSB has about $3 billion in total assets, so it is similarly sized to the First Connecticut purchase, but was substantially cheaper. BSB is a focused community bank with only six branches in the Boston area as People’s continues to build market share in that very competitive market. BSB has done a nice job in recent years growing assets, loans and deposits and People’s is certainly looking to take advantage of BSB’s past success.
The BSB purchase has a tangible book value payback period of 3.1 years, so it is more favorably priced than First Connecticut, and should be immediately accretive to earnings-per-share upon consummation of the acquisition. The acquisition will take People’s Boston market share from 13th today to 8th on a pro-forma basis, so the purchase is a meaningful step towards increased competitiveness in that critical market.
We see People’s as being able to produce 5% earnings-per-share growth annually over full economic cycles given that its growth-by-acquisition strategy is lumpy and unpredictable, but also because People’s is subject to the same risks as other banks.
In other words, with the yield curve flattening out significantly in recent quarters, we see organic growth in earnings as tough to come by for all banks, People’s included. In addition, since it issues stock for acquisitions, its share count rises fairly rapidly over time, introducing a significant headwind for earnings-per-share even if dollar earnings grow nicely.
Still, we see the bank as a strong operator and one that focuses heavily on cost savings, so we think it has some meaningful growth in front of it.
Competitive Advantages & Recession Performance
Competitive advantages are difficult to come by for banks given that they largely offer the same products and services as their competitors. However, one way to offer an advantage is to grow scale in key markets, and that is exactly what People’s is doing with Boston as an example.
Growing scale and name recognition in key markets like that can help drive efficiency and scale and that is part of the reason why People’s has been able to boost margins in recent quarters, despite the flattening yield curve. This key strategic pillar is a differentiator and we think it will serve People’s well in the coming years.
However, that certainly does not insulate People’s from economic downturns. Its performance during the Great Recession wasn’t great, but it did fare much better than many of its larger competitors.
People’s earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $0.52
- 2008 earnings-per-share of $0.42 (19% decline)
- 2009 earnings-per-share of $0.30 (29% decline)
- 2010 earnings-per-share of $0.24 (20% decline)
While People’s remained profitable throughout, the damage was significant. Indeed, it was 2011 before People’s earnings-per-share crested its pre-recession high, hitting $0.57 in that year to top 2007’s level of $0.52. Growth has been robust since that time, however, and the company is expected to generate earnings-per-share of $1.45 this year.
Valuation & Expected Returns
People’s has a current price-to-earnings ratio of 11.6 based on our estimate of $1.45 of earnings-per-share for this year. This is meaningfully lower than our fair value estimate of 13 times earnings, so we see People’s as somewhat undervalued after recent weakness in the stock. The 10-year historical valuation multiples for People’s stock can be seen in the following image:
Thus, People’s offers good value at current prices. Should the stock revert to our estimate of fair value, it would provide a 2% to 3% annual tailwind to total returns for shareholders.
In addition, we see earnings-per-share growth at 5% annually, combined with the current 4.2% yield. In total, annual returns are expected to reach approximately 12%, which is good enough to earn a buy recommendation, particularly for income investors interested in the high current yield.
The payout ratio is also right at half of earnings after years of slow payout growth. This was necessary as People’s payout ratio used to exceed earnings, but it is in a much better spot now. Keep in mind that all-stock acquisitions make the dividend costlier even if it isn’t raised on a per-share basis, so growth will likely be muted. We are forecasting low single digit growth in the payout in the coming years for this reason.
People’s has an attractive dividend yield above 4%, and growth potential for the years ahead. The bank is not immune from economic downturns, and a flat yield curve is a risk. However, People’s has proven adept over the years at finding and acquiring reasonably priced growth in its key markets, and we have no reason to believe that won’t continue.
People’s is an appealing stock for its relatively low valuation, strong competitive position in key markets in the Northeast, and its 4%+ yield. For these reasons, we rate People’s a buy.