Commercial Lending Expansion And Stock Buybacks Will Create Shareholder Value

Key Takeaways

• Loan growth and decreased deposit costs are strengthening net interest margins, driving revenue and earnings expansion.
  
• Strategic balance sheet repositioning and disciplined credit management are expected to boost pretax income and support stable earnings.
  
• Declining loan yields, deposit pressures, and credit quality risks threaten net interest margins, while noninterest expenses and strategic repositioning may impact short-term earnings.

Catalysts

Operates as the bank holding company for Heritage Bank that provides various financial services to small and medium sized businesses and individuals in the United States.

• Heritage Financial has experienced strong loan growth, with loan balances increasing significantly. The expansion of loan production, particularly in commercial lending, is expected to drive future revenue growth.
  
• The company has successfully decreased the cost of deposits and borrowings, leading to an improvement in net interest margin. This margin expansion is projected to contribute positively to future net margins and earnings.
  
• Heritage Financial's strategic balance sheet repositioning, including loss trades on investments and restructuring of the BOLI portfolio, is anticipated to yield higher pretax income and improve future earnings performance.
  
• Continued focus on disciplined credit underwriting and portfolio management is expected to maintain strong credit quality, minimizing credit losses and supporting stable net margins and earnings.
  
• The company is committed to stock buybacks, supported by strong capital ratios, which are likely to enhance earnings per share and create value for shareholders moving forward.

Heritage Financial Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Heritage Financial's revenue will grow by 13.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 20.5% today to 31.8% in 3 years time.
• Analysts expect earnings to reach $98.9 million (and earnings per share of $2.92) by about January 2028, up from $43.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.7x on those 2028 earnings, down from 19.8x today. This future PE is lower than the current PE for the US Banks industry at 12.3x.
• Analysts expect the number of shares outstanding to decline by 0.17% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.16%, as per the Simply Wall St company report.

Heritage Financial Future Earnings Per Share Growth

Risks

• A reduction in the Fed funds rate led to a decreased yield on the loan portfolio, which could impact future net interest income and margins.
  
• The decrease in total deposits, combined with flat growth in Q4, could place pressure on funding for loan growth and negatively impact net interest margin.
  
• A significant pretax loss from investment sales was recognized, which could potentially impact short-term earnings despite strategic repositioning efforts aimed at long-term benefits.
  
• A rise in criticized loans and the downgrade of several C&I relationships highlight potential risks in credit quality, potentially affecting future provision expenses and net earnings.
  
• Noninterest expenses have increased, albeit modestly, which could impact net margins if not managed effectively alongside other increasing costs such as compensation and vendor expenses.

Valuation

• The analysts have a consensus price target of $29.4 for Heritage Financial based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $33.0, and the most bearish reporting a price target of just $25.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $311.3 million, earnings will come to $98.9 million, and it would be trading on a PE ratio of 11.7x, assuming you use a discount rate of 6.2%.
  
• Given the current share price of $25.25, the analyst's price target of $29.4 is 14.1% higher.
  
• 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.