Bank Of Montreal Dividend Stock Analysis 2015 (NYSE:BMO) (2024)

Bank of Montreal (NYSE:BMO) is one of the Big Five Canadian banks and is the oldest Canadian bank. Although the market cap makes it the second smallest of the Big Five, BMO has a strong history that has stood the test of time since the early 19th century.

Note: All numbers below are in CAD$ unless otherwise specified.

Corporate Profile (from Yahoo Finance)

Bank of Montreal offers various banking products and services in Canada, the United States, and internationally. The company’s personal and commercial banking products and services include chequing and savings accounts; banking services, including 24/7 banking, direct deposits, bill payments, overdraft services, money transfers, wire transfers, and travel insurance; credit cards; mortgages; loans and lines of credit; and creditor insurance. It also offers savings plan, investment certificates and mutual funds, online investing, and exchange traded funds; and financial planning services. In addition, the company provides wealth management services, such as full service investment advice, private banking, financial planning, and global asset management services, as well as equity and debt underwriting, corporate lending and project financing, merger and acquisitions advisory services, securitization, treasury management, risk management, debt and equity research, and institutional sales and trading. It operates approximately 1,550 bank branches in Canada and the United States. The company serves small business, commercial, high net worth, corporate, institutional, and government clients. Bank of Montreal was founded in 1817 and is headquartered in Montreal, Canada.

A Closer Look

BMO is the oldest Canadian bank and is the second smallest of the Big Five Canadian banks. The company's peers include Royal Bank of Canada (RY), Toronto-Dominion Bank (TD), Bank of Nova Scotia (BNS), and Canadian Imperial Bank of Commerce (CM).

(Source: Created by author. Data from Google Finance & Morningstar)

BMO is well diversified and has a big exposure to the U.S. market. As per the 2014 annual reports, BMO has 65.3% of its revenue generated in Canada, 30% in U.S., and 4.5% in Other International.

(Source: Created by author. Data from respective 2014 annual reports)

Outlook and Risks

The Canadian banks are regarded as some of the safest financial institutions in the world. The companies have a long track record of being conservative and focus on long-term stability and prosperity. Most of these institutions have existed and paid dividends for more than 150 years and make for great core positions in any investor's portfolio. However, there are some risks that also have to be considered before investing in them:

• The slump in the commodities market has pushed the Canadian economy to the brink of recession. This has caused the Bank of Canada (BoC) to reduce the overnight interest rates twice this year -- first in Jan 2015 and second in July 2015, each time with 25 basis points. The current overnight interest rates stand at 0.50%.
• There is a silver lining here for shareholders of the bank. The banks have decided to increase the spread between overnight interest rate set by BoC and the prime rate. The spread increased (see image below) to 2.1% in Jan 2015 and has now increased to 2.2%, giving them the possibility of higher and easier profits in the coming quarters.
• The Canadian housing market is in a bubble territory according to many economists. If the bubble pops, the banks, although protected by the taxpayer backstopped CMHC insurance, will still face some problems going forward. The BoC has in the past acknowledged that the housing market is overheated and is hoping for a soft landing.
• The depressed look on the Canadian economy has caused the Canadian dollar to take a dive -- now down almost 30% since its peak in 2011. The exposure to international market, especially U.S. market, is advantageous to banks with huge operations in the U.S., such as BMO. However, income investors should also keep in mind that the dividends received will be affected as they are declared and issued in CAD$.

(Source: Created by author. Data from Bank of Canada)

Dividend Stock Analysis

Financials

Expected: A growing revenue, earnings per share and free cash flow year-over-year looking at a 10-year trend.

(Source: Created by author. Data from Morningstar)

Actual: Financials are well in order -- with a growing revenue year over year after a slight downturn during the financial crisis. Earnings have also increased steadily over the years.

Dividends and Payout Ratios

Expected: A growing dividend outpacing inflation rates, with a dividend rate not too high (which might signal an upcoming cut).

(Source: Created by author. Data from Morningstar)

Actual: BMO has a longest track record of paying dividends in Canadian corporate history -- an unbroken chain of dividends paid since 1829. The dividends have never been reduced and dividend payment has been top priority of BMO. The company froze dividend raises during the financial crisis (between 2008 and 2011), but has started raising them again since. The current yield is 4.49%, with an EPS payout ratio at 49.6%.

Outstanding Shares

Expected: Either constant or decreasing number of outstanding shares. An increase in share count might signal that the company is diluting its ownership and running into financial trouble.

(Source: Created by author. Data from Morningstar)

Actual: The number of outstanding shares grew during the financial crisis, and reached a peak in 2012. However, the number of shares have started decreasing. In December 2014, BMO announced that it would repurchase up to 15 million shares.

Book Value and Book Value Growth

Expected: Growing book value per share.

(Source: Created by author. Data from Morningstar)

Actual: The book value at BMO has grown steadily over the years and maintains a great upward trajectory.

Valuation

To determine the valuation, I use the Graham Number, Average Price-to-Earnings, Average Yield, Average Price-to-Sales, Dividend Discount (Gordon Growth model) and Discounted Cash Flow. For details on the methodology, click here.

The Graham Number for BMO with a book value per share of $50.74 and ttm EPS of $6.37 is $85.28. Based on last closing price, the stock is currently 14.42% undervalued.

BMO's 5-year average P/E is 11.16 and the 10-year average P/E is 12.34. Based on the analyst earnings estimate of $6.79, we get a fair value of $75.78 (based on 5-year average) and $83.79 (based on 10-year average).

BMO's average yield over the past five years and ten years was 4.57%. Based on the current annual payout of $3.28, that gives us a fair value of $71.77.

The average 5-year P/S is 2.70 and average 10-year P/S is 2.78. Revenue estimates for next year stand at $28.57 per share, giving a fair value of $77.14 and $79.42 based on 5- and 10-year averages, respectively.

The Gordon Growth Model is a quick way to calculate the fair value of a company using the current dividend, the expected dividend growth rate, and our required rate of return or discount rate. Using an expected rate of return of 10%, and a dividend growth rate of 6%, we get a fair value of $83.00.

The consensus from analysts is that earnings will rise at 10% per year over the next five years. If we take a more conservative number at 6% (considering all the headwinds facing the Canadian economy currently) and assume that BMO is growing its earnings by 5% thereafter, running the three-stage DCF analysis with a 10% discount rate (expected rate of return), we get a fair price of $104.95.

The following chart from F.A.S.T Graphs provides a perspective on how undervalued BMO is. This page describes how to interpret the graphs.

(Source: F.A.S.T Graphs)

The Estimates section of F.A.S.T Graphs predicts that if the stock stays at P/E value of 10.5 a year from now, that would result in a 5.2% return, but even if it goes to a very possible P/E of 12, the one year return can be close to 21%.

(Source: F.A.S.T Graphs)

Conclusion

The Canadian banks are regarded as some of the safest financial institutions in the world. The companies have a long track record of being conservative and focused on long-term stability and prosperity. BMO has existed as an institution since 1817 and paid dividends since 1829, and makes for a great core position in any investor's portfolio. There are plenty of headwinds facing the Canadian economy and the banks -- including a recession, weak Canadian dollar, possibility of a housing bubble and potential crash, which has lead to very attractive valuation levels for investors looking to initiate or add to their positions. Based on the valuation metrics used above, the average fair value is computed to be $81.09, indicating that the stock is currently 10% undervalued. I wrote in this article in February 2015 that the Canadian banks will face headwinds for the rest of the year and slow addition of shares was recommended. My recommendation still stands, as the headwinds are expected to continue and anyone looking for great long-term holdings in the financial sector should look at the Canadian banks over the coming months.

Full Disclosure: Long BNS, TD. My full list of holdings is available here.

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