Huntington Bancshares Is Up To 40% Undervalued, As I See A Path To $18

seekingalpha2023-12-18

Regional banks have historically underperformed the market and face challenges such as lack of consistent dividend growth.Huntington Bancshares has a strong balance sheet, robust credit metrics, and a...

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Vladislav Stepanov/iStock via Getty ImagesIntroduction Although I tend to make exceptions, I generally only buy wide-moat businesses with attractive volatile profiles, consistent dividend growth, healthy balance sheets, and the ability to outperform the market on a rather consistent basis. Regional banks are clearly in a different category.  They do not have wide moats, as their bread and butter (lending) is a market of thousands of players. Meanwhile, diversified regional banks with investment management and related exposure compete with large banks and asset managers. Most banks do not have consistent dividend growth, as steep recessions often force them to increase reserves. The Great Financial Crisis is an infamous example of widespread dividend cuts. Related to the Great Financial Crisis, banks have failed to outperform the market, as recessions tend to cause such high drawdowns that it takes a very long time before shares recover.  If you had bought regional banks (KRE) before the Great Financial Crisis, you would be up just 33%. This includes dividends! The banking (including large banks) industry (KBE) did better, returning 69%. Meanwhile, the financial sector (including a wide variety of financial industries), as represented by the Financial Select Sector SPDR (XLF) ETF, returned 108%. Data by YChartsWhile all of these returns are bad, we clearly see that regional banks are the worst place to be, at least on a long-term basis. Having said that, I like regional banks as trading vehicles and semi-long-term investments. For example, Huntington Bancshares (NASDAQ:HBAN), the star of this article, was added to my portfolio in 2020, when the bank was part of research I did for a major fund. After all, I believe buying beaten-down regional banks during recessions is a great way to buy a juicy yield and elevated total return potential until the economy cools again.  “You make most of your money in a bear market, you just don’t realize it at the time.” Shelby Cullom Davis  With that in mind, I moved Huntington Bancshares into my trading portfolio, as I won't add to it for the aforementioned reasons. However, I'm not selling at these levels, either. As we'll discuss in this article, I believe that HBAN shares are undervalued, with a path to $18 per share. At that level, I'm likely to sell my position to free up more cash for less risky investments. Despite Headwinds, HBAN Remains In A Good Spot When I decided to buy Huntington Bancshares, a big part of my reasoning was the company's largest footprint in the Midwest, which has only gotten bigger after it bought TCF Financial. During the pandemic, for example, it was one of the biggest banks for pandemic loans, which underlined how relevant the bank was (and still is) for the U.S. economy. As we can see in the overview below, the bank has outperformed peers in deposit growth by nearly ten percentage points since the end of 2021. It has built one of the most granular deposit bases with leading insured deposit percentages. Huntington BancsharesAverage deposits increased by $2.6 billion or 1.8% from the prior quarter. The sustained growth in deposit balances was observed throughout the quarter, with sequential increases in July, August, and September, aligning with trends seen in previous periods. Huntington BancsharesLiquidity is best-in-class, covering uninsured deposits at nearly twice the level of peers. Furthermore, the bank's adjusted CET1 ratio is strong and near the top of the peer group. During its 3Q23 earnings call, the bank said that plans are in place to drive this ratio higher throughout the year and into 2024, positioning the bank well ahead of proposed Basel III requirements. In general, Huntington's credit metrics, including net charge-offs and credit reserves, are top-tier and differentiate the bank in the industry. As of the third quarter, credit quality remained strong, with net charge-offs at 24 basis points and allowance for credit losses at 1.96%. Return on capital was robust, driving capital accretion with reported CET1 above 10%. Huntington BancsharesWhile net charge-offs increased by eight basis points compared to the previous quarter, they remain consistent with the guidance for full-year net charge-offs. Nonperforming assets increased, which was attributed to risk rating changes in commercial real estate. Loan balances decreased by $561 million or 0.5%, primarily driven by lower commercial loan balances, reflecting intentional optimization efforts. Huntington BancsharesCommercial loan changes included declines in CRE balances and distribution finance, offset by increases in Auto Floorplan. The growth in consumer borrowing was mainly driven by residential mortgages and RV/Marine loans, while auto loan balances experienced a decline. With regard to the changes in interest rates, net interest income increased by $22 million or 1.6% to $1.379 billion in the third quarter. The expansion was driven by a rising net interest margin (\"NIM\"). The NIM increased by nine basis points on a GAAP basis and ten basis points on a core basis, excluding accretion. Factors contributing to the higher NIM included a higher spread net of free funds, lower Fed cash balances, and higher FHLB stock dividends. The interest rate environment, with rates rising during the quarter, contributed to the net benefit to NIM. Huntington BancsharesOne method the company uses to enhance yields is hedging. The hedging program during the third quarter included a substantive increase in the forward starting pay fix swaption strategy, which rose by $5.9 billion to a total of $15.5 billion. This program is designed to protect capital from tail risks in significant up-rate scenarios. With regard to its securities portfolio, the level of cash and securities in the portfolio saw a slight decrease from the prior quarter. During Q3, the bank made strategic adjustments by lowering some of the elevated cash held in Q2. Notably, proceeds from securities cash flows were not reinvested, contributing to a modest decrease in the securities balance. The bank also actively manages the duration of its portfolio, and during Q3, the duration was lowered. This aligns with the management approach that has been in place since 2021. The decision not to reinvest securities cash flows and to hold proceeds in cash reflects a dynamic strategy based on prevailing market conditions and the attractiveness of short-term rates. Huntington BancsharesAdding to that, the contingent and available liquidity remained robust at $91 billion, representing 204% of total uninsured deposits at quarter end. This substantial liquidity position positions the bank favorably, providing peer-leading coverage and reinforcing its ability to respond to various market scenarios. Huntington BancsharesThis brings me to its dividend. Dividend & Valuation HBAN pays a $0.155 per share per quarter dividend. That may not seem like a lot. However, as its shares are trading at roughly $13, this translates to a yield of 4.8%. The most recent hike was on October 22, 2021, when the company hiked by 3%, which is a bit underwhelming. Data by YChartsThis dividend is protected by a 51% payout ratio, which is very low. Hence, I expect the company to boost its dividend more aggressively the moment the economic environment poses less of a threat. Speaking of the economic environment, this year, the bank is expected to see a 6% EPS contraction, followed by another 8% decline in 2024. 2025 is expected to see a recovery with 6% EPS growth. Currently, HBAN trades at a blended P/E ratio of 9.7x. Its long-term normalized valuation multiple is 13.8x. A return to that multiple by incorporation of its earnings growth expectations would give us a fair price target of roughly $18.20. FAST GraphsAlthough I do not expect the bank to reach this target under current circumstances, I am holding onto my shares, prepared to sell my position at higher prices. As I started my investment at roughly $9.30, it would be an attractive return. Needless to say, due to elevated economic risks, we could see more downside before reaching this target. My biggest worry is that sticky inflation keeps the Fed from cutting rates as fast as the market currently expects. That could do serious damage to credit quality and keep investors from buying bank stocks - even banks with strong balance sheets. So, please be aware of these risks. Treat banks like risky investments and only buy on stock price weakness if you believe that banks are right for you. Takeaway Huntington Bancshares, despite short-term challenges, stands out with a robust Midwest footprint, strong deposit growth, and superior liquidity. While facing headwinds like economic uncertainties and potential EPS contractions, HBAN's conservative dividend payout and undervaluation make it a compelling recovery play.  The strategic management of assets, hedging programs, and a focus on credit quality further strengthen its position.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2392996085"}