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The Bank of Montreal Looks Attractive After Falling More Than 40%

My tour of the Canadian financials continues. Like I've said in previous articles, I like that the major banks in Canada did not cut dividends during the last recession. Each of the bank stocks has also had a significant decline to start 2020, which has driven the yields above 5% for each name. I've previously discussed Canadian Imperial (CM), Royal Bank of Canada (NYSE:RY) and The Bank of Nova Scotia (NYSE:BNS).

I will now focus on the Bank of Montreal (NYSE:BMO), which has declined almost 43% year to date but sports a 7%-plus dividend yield.

Company background and recent earnings results

Headquartered in Toronto, the Bank of Montreal is among the largest financial institutions in Canada. The company also has operations in the U.S. as well as nearly 20 other foreign countries. Slightly more than half of its loan portfolio is composed of business and government loans. Residential mortgages accounted for 29% of loans last fiscal year, with consumer loans and credit cards making up the remainder of the loan portfolio. Unless otherwise noted, all figures are reported in U.S. dollars. The Bank of Montreal has a market capitalization of $28.4 billion, making it the fourth-largest of Canada's major banks.

The Bank of Montreal reported first-quarter 2020 results on Feb. 25 (the company's fiscal year ends Oct. 31). Adjusted earnings per share increased 2.8% to $1.81. This was 3 cents ahead of estimates. Revenue improved 7% to $4.6 billion, $140 million higher than expected.

For this section, figures are listed in Canadian dollars. The Canadian banking segment had net income growth of 8% year over year. Deposits grew 14%, split between personal and commercial accounts. Commercial loan growth improved 15%.

Net income for the U.S. banking segment deceased 21%. Results were negatively impacted by recent interest rate decreases in the U.S. Also impacting results were higher provisions for credit losses due to the ongoing Covid-19 pandemic. The shutdown of non-essential businesses is likely to lead to a higher number of impaired loans in future quarters. These losses were partially offset by higher revenue for the segment.

BMO Wealth Management grew 22%. Assets under management increased 9% to $893 billion. This helped drive a 21% increase in traditional wealth net income even as client expenses were lower compared to the previous year. Insurance improved 26% due to positive market movements. Loans were higher by 14%, with deposits growing 12%.

BMO Capital Markets had net income growth of 39%. This segment had strong revenue growth in its Global Markets and Investment & Corporation Banking businesses. These gains were only partially offset by higher expenses and provisions for loan losses in the oil and gas market. U.S. earnings accounted for 40% of net income in the first quarter.

Overall, the Bank of Montreal had a solid quarter. Top-line growth was strong, bottom-line results improved from the previous year and the company beat analysts' estimates in both areas. The company did have to add more than 200 million Canadian dollars ($141.7 million) to its provisions for credit losses, but this, as stated in previous discussions of this sector, isn't unexpected given the economic damage that the Covid-19 pandemic has caused on economies in both the U.S. and Canada. Stay-at-home directives and the forced closure of non-essential businesses to slow the spread of the virus is likely to lead to higher provisions for credit losses over the next few quarters.

Even so, income investors shouldn't worry about the Bank of Montreal's ability to continue paying its dividend. Dividend payments have been in the company's DNA for a very long time.

Dividend and valuation analysis

The Bank of Montreal has paid a dividend every year since 1829. At 191 years, this is the longest-running payout record of any company in Canada. While future dividend payments aren't a guarantee for any company, it is highly likely that even the Covid-19 pandemic will cause enough disruption to the Bank of Montreal's business given its history of overcoming other difficult economic conditions.

Like its Canadian peers, the Bank of Montreal froze its dividend during the last recession. Unlike its peers, the company held its dividend payment steady from 2009 through 2011. Growth over the last decade is just 3.8% in Canadian dollars. U.S. investors have experienced an even lower dividend growth rate of 1.3% over that same period of time. Those looking for a higher growth rate will have to be content with a low dividend growth. Helping to compensate for this is the stock's current yield of 7.1%.

Still, the dividend looks to be very safe. U.S. investors are expected to receive $3.12 in dividends per share in 2020, while analysts expect $6.79 of earnings per share for the year. This gives the company an expected payout ratio of under 46% for the year, just below the average payout ratio over the last decade.

Shares of the Bank of Montreal closed at $44.31 on Friday. Using earnings per share estimates for the year, the stock has a forward price-earnings ratio of 6.5. For context, the stock has an average multiple of 11.4 times earnings over the last decade. If shares were to trade in a price-earnings range of 8 to 10, then the stock would be worth $54 to $68 using current estimates. This would be a 22% to 53% return from the current share price, which doesn't include the stock's yield.

Final thoughts

The Bank of Montreal has had a difficult start to 2020, just like many of the other names in the sector. Loan impairments are likely to rise related to the Covid-19 pandemic and lower interest rates in the U.S. will negatively impact the company's business.

Despite this, I find the stock attractive as it trades with a very low forward price-earnings ratio. The Bank of Montreal also has the highest upside potential in my estimation of all of the Canadian banks that I have reviewed over the past several weeks. Dividend growth will likely disappoint, but the 7.1% yield appears safe. Those looking for a bank stock with upside potential and a high yield should consider buying the Bank of Montreal.

Author disclosure: The author is not long any stocks mentioned in this article.

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This article first appeared on GuruFocus.