Critical Shifts And High Costs Spell Trouble For Bank's Future Earnings

Key Takeaways

• Strategic emphasis on maintaining strong capital and adjusting loan portfolios may suppress future earnings growth and impact return on equity.
  
• Increased operational expenses from expanding lending programs could narrow net margins if anticipated revenue boosts do not materialize.
  
• Stellar Bancorp's strategic focus on small-to-medium business lending, personnel enhancements, deposit stability, balanced loan portfolio management, and regulatory capital growth suggests diversified revenue growth and financial resilience.

Catalysts

Operates as the bank holding company that provides a range of commercial banking services primarily to small and medium-sized businesses, professionals, and individual customers.

• The company's cautious stance towards loan growth amidst a high interest rate environment and an uncertain economic outlook suggests future revenue from loans could be suppressed, impacting net interest income.
  
• A decrease in loan origination and an increase in payoffs, as indicated by management's plan to manage the commercial real estate portfolio within regulatory guidance, suggest potential declines in portfolio growth, affecting future interest revenues.
  
• The emphasis on maintaining a strong capital position and the mention of building a larger securities portfolio hint at a strategic shift that could dampen future earnings growth if not offset by higher yielding loan assets, potentially impacting return on equity.
  
• The stabilization of noninterest-bearing deposits after outflows could suggest a cap on the cost of funds benefit, possibly pressuring net interest margin if deposit costs rise or if the interest rate environment shifts unfavorably.
  
• The commitment to higher personnel and development program costs for expanding small-to-medium business lending and C&I loans indicates increased operational expenses that could narrow net margins if the revenue boost from these initiatives does not materialize as expected.

Assumptions

• Analysts are assuming Stellar Bancorp's revenue will decrease by 0.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 26.3% today to 21.3% in 3 years time.
• Analysts expect earnings to reach $93.6 million (and earnings per share of $1.73) by about September 2027, down from $114.1 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 19.5x on those 2027 earnings, up from 12.0x today. This future PE is greater than the current PE for the US Banks industry at 11.5x.
• Analysts expect the number of shares outstanding to grow by 0.5% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.8%, as per the Simply Wall St company report.

Risks

• The company's strategic shift towards emphasizing small- to medium-sized business lending and acquiring operating accounts indicates a potential for diversified revenue growth, impacting net margins positively.
  
• Stellar Bancorp's officer development program and focus on adding experienced personnel could enhance its commercial & industrial (C&I) lending capabilities, potentially increasing earnings through new business acquisition.
  
• The stabilization of noninterest-bearing deposits after previous outflows and the plateauing cost of interest-bearing liabilities could signify stronger deposit base stability, positively impacting net interest income levels.
  
• Effective management of the loan portfolio, including reductions in commercial real estate concentrations and a strategic shift towards a more balanced lending approach, coupled with stable credit quality, suggests potential for improved loan performance and reduced credit risk, impacting provision expenses and net charge-offs favorably.
  
• The company's successful growth in regulatory capital ratios demonstrates financial resilience, which may allow for future growth opportunities, both organic and through acquisitions, potentially enhancing earnings and shareholder value.

Valuation

• The analysts have a consensus price target of $28.6 for Stellar Bancorp based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $440.0 million, earnings will come to $93.6 million, and it would be trading on a PE ratio of 19.5x, assuming you use a discount rate of 5.8%.
• Given the current share price of $25.5, the analyst's price target of $28.6 is 10.8% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• 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.