Cloud Investments And Commercial Real Estate Pivot Will Pressure Margins And Earnings Outlook

Catalysts

About Laurentian Bank of Canada

Laurentian Bank of Canada is a regional bank that provides commercial and personal banking services, with a growing focus on specialized commercial lending and inventory financing across North America.

What are the underlying business or industry changes driving this perspective?

• Large, front-loaded technology and cloud migration investments running through operating expenses until at least 2026 risk failing to deliver sufficient scale benefits in a slow-growth environment. This could lock in structurally weak efficiency ratios and keep earnings growth muted.
• Dependence on a recovery in U.S. consumer and dealer demand to lift inventory finance utilization back toward historical levels may be overly optimistic if rates stay higher for longer or confidence fails to rebound. This could limit anticipated revenue uplift and net interest income expansion.
• Strategic pivot toward commercial real estate and equipment lending, including a sizable multi-residential pipeline, increases exposure to a credit cycle turn at a time of rising gross impaired loans. This could drive higher future provisions and pressure net margins.
• Reliance on broker and adviser deposits and potential alternative U.S. funding structures exposes the bank to future repricing and competitive funding pressures. This could erode net interest margin if deposit costs outpace asset yield growth.
• Maintaining CET1 significantly above internal targets to backstop potential inventory finance and commercial loan growth ties up capital in anticipation of opportunities that may not fully materialize. This could dampen return on equity and limit per share earnings growth.

Assumptions

This narrative explores a more pessimistic perspective on Laurentian Bank of Canada compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Laurentian Bank of Canada's revenue will grow by 4.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 14.4% today to 13.8% in 3 years time.
• The bearish analysts expect earnings to reach CA$146.1 million (and earnings per share of CA$3.77) by about December 2028, up from CA$134.7 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as CA$161.8 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.6x on those 2028 earnings, down from 13.2x today. This future PE is lower than the current PE for the CA Banks industry at 15.1x.
• The bearish analysts expect the number of shares outstanding to grow by 0.69% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.26%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Sustained secular demand in core inventory finance end markets such as agriculture and power sports, together with an expanding dealer base that grew 4% year to date, could drive utilization back toward historical levels in the high 40s and materially lift net interest income and overall revenue.
• The long-term pivot toward specialized commercial banking, including multi residential commercial real estate where volumes grew 5% in the quarter and 22% year over year in some segments, could structurally improve the loan mix and pricing power, supporting higher net interest margin and earnings.
• Ongoing technology simplification and cloud migration, alongside prior platform divestitures and distribution streamlining, may eventually convert today’s elevated 75.7% efficiency ratio into durable cost savings, improving operating leverage, net margins and return on equity over the medium term.
• Strong capital and liquidity positions, including a CET1 ratio of 11.3% and liquidity coverage at the high end of the industry, provide capacity to fund higher yielding growth in inventory finance and commercial real estate, which could accelerate asset growth, boost spreads and enhance earnings stability.
• Prudent underwriting, high collateralization with about 95% of loans secured and elevated allowance coverage maintained since the pandemic may limit future credit losses even through a softer economic cycle, reducing downside risk to provisions, preserving net income and supporting more resilient earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Laurentian Bank of Canada is CA$25.0, which represents up to two standard deviations below the consensus price target of CA$32.88. This valuation is based on what can be assumed as the expectations of Laurentian Bank of Canada's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$40.5, and the most bearish reporting a price target of just CA$25.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be CA$1.1 billion, earnings will come to CA$146.1 million, and it would be trading on a PE ratio of 9.6x, assuming you use a discount rate of 7.3%.
  
• Given the current share price of CA$39.97, the analyst price target of CA$25.0 is 59.9% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.