Loan Growth And Repriced CDs Expected To Improve Future Profitability

Key Takeaways

• Strategic repricing of maturing CDs and effective expense management aim to improve interest income and net margins.
  
• Anticipated loan growth and balance sheet repositioning support increased revenue and future earnings growth.
  
• Credit quality concerns, competitive deposit costs, and potential investment volatility pose risks to margins and profitability, despite some positive loan quality indicators.

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 expects significant repricing of $420 million in certificates of deposit (CDs) maturing at lower rates, potentially reducing interest expenses and improving net interest income.
  
• The company anticipates continued loan growth, driven by a strong commercial loan pipeline, which could contribute to increased revenue.
  
• The strategic repositioning of the balance sheet through investment sales is expected to enhance pretax income by approximately $3 million annually, supporting future earnings growth.
  
• Effective expense management and potential overhead ratio improvements may lead to better net margins and overall profitability.
  
• Stock buybacks continue as a priority, enhancing earnings per share through reduced share count.

Heritage Financial Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Heritage Financial's revenue will grow by 13.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 18.4% today to 31.8% in 3 years time.
• Analysts expect earnings to reach $94.6 million (and earnings per share of $2.8) by about December 2027, up from $37.6 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.2x on those 2027 earnings, down from 23.3x today. This future PE is lower than the current PE for the US Banks industry at 12.9x.
• Analysts expect the number of shares outstanding to decline by 0.29% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.04%, as per the Simply Wall St company report.

Heritage Financial Future Earnings Per Share Growth

Risks

• The significant charge-offs during Q3, particularly the owner-occupied CRE loan, might indicate underlying credit quality issues. If these issues persist, they could negatively impact net margins due to higher provisions for credit losses.
  
• High competition for deposits is keeping deposit costs elevated, which may pressure net interest margins and result in reduced net interest income over time.
  
• A substantial portion of CDs are maturing soon at a high average cost, and despite expectations to reprice them lower, persistent high rates due to competition could impact revenue if not managed effectively.
  
• The loss of $6.9 million on securities indicates potential volatility in investment income or strategic repositioning issues, which could affect earnings if similar actions are needed in the future.
  
• The decrease in criticized loans is positive, but the persistence of nonaccrual loans and charge-offs connected to specific loans may signal ongoing credit risks that could necessitate further loss provisions, affecting profitability and net margins.

Valuation

• The analysts have a consensus price target of $27.0 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 $29.0, and the most bearish reporting a price target of just $24.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $297.5 million, earnings will come to $94.6 million, and it would be trading on a PE ratio of 11.2x, assuming you use a discount rate of 6.0%.
• Given the current share price of $25.67, the analyst's price target of $27.0 is 4.9% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• 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.