First Business Stock: Positive Top-Line Growth Outlook (NASDAQ: FBIZ)

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Business Loan Application Form Approved

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Earnings of First Business Financial Services (NASDAQ: FBIZ) will likely dip this year relative to last year but remain much higher than the pre-pandemic level. A higher commission expense, net of reversals, will likely be the biggest reason for an earnings decline. On the other hand, heightened business activity will likely drive loan growth, which will, in turn, support the bottom line. Further, the margin is moderately sensitive to interest rate changes; therefore, the rising interest-rate environment will have a positive impact on the top line. Overall, I’m expecting First Business Financial to report earnings of $ 3.60 per share in 2022, down 14% year-over-year. The year-end target price suggests a decent upside from the current market price. Based on the total expected return, I’m adopting a buy rating on First Business Financial Services.

Loan Growth to Match Last Year’s Level

First Business Financial’s loan portfolio grew by a strong 5.5% by the end of December 2021 from the end of September 2021 (22% annualized). Excluding Paycheck Protection Program (“PPP”) loans, the total loan portfolio grew by a whopping 29.8% annualized in the last quarter of 2021, as mentioned in the earnings release.

The loan growth momentum will most probably continue this year partly because there’s only limited PPP forgiveness remaining. PPP loans outstanding totaled $ 27.9 million at the end of December 2021, representing just 1.2% of total loans. Therefore, their forgiveness in the year ahead will have a small impact on the total loan portfolio size.

As the name suggests, First Business Financial focuses on lending to businesses. Therefore, the national purchasing managers index, PMI, is a good gauge of future credit demand. The index has been in the expansionary territory throughout the past year, as seen below, which suggests that the demand for credit will remain robust.

Chart
Data by YCharts

Further, the Mortgage Bankers Association expects strong nationwide GDP growth of 3.1% this year. Considering these economic factors, I’m expecting loan growth to remain robust this year.

First Business Financial’s loan portfolio has managed to grow by mid-single digits in the past. Considering the factors mentioned above, I believe similar growth is possible in 2022. I’m expecting loans to increase by 4.5% by the end of December 2022 from the end of 2021. Meanwhile, I’m expecting other balance sheet items to grow mostly in line with loans. The following table shows my balance sheet estimates.

Source: SEC Filings, Author’s Estimates

(In USD million unless otherwise specified)

FY17 FY18 FY19 FY20 FY21 FY22E
Financial Position
Net Loans 1,483 1,597 1,695 2,117 2,215 2,314
Growth of Net Loans 3.7% 7.7% 6.1% 24.9% 4.6% 4.5%
Other Earning Assets 201 245 262 246 276 289
Deposits 1,394 1,455 1,530 1,856 1,958 2,046
Borrowings and Sub-Debt 218 309 337 436 419 438
Common equity 169 181 194 206 232 256
Book Value Per Share ($) 19.7 20.9 22.8 24.6 28.0 30.8
Tangible BVPS ($) 18.2 19.5 21.4 23.2 26.5 29.3

Margin to Expand Despite Highly Sensitive Deposit Book

Although First Business Financial’s commercial-heavy loan portfolio is sensitive to rate changes, the net interest income is not highly sensitive because of the liability mix. Interest-bearing transaction accounts and money market accounts made up a sizeable 65.6% of total deposits at the end of 2021, according to details given in the 10-K filing. These deposits will re-price soon after rate hikes in the year ahead. As a result, the net interest margin is likely to be only moderately sensitive to rate changes this year.

The management’s interest-rate sensitivity analysis given in the 10-K filing shows similar results. According to the analysis, a 200-basis points increase in interest rates can boost the net interest income by 5.64% over twelve months.

Considering these factors, I’m expecting the margin to remain mostly stable in the first half of this year and increase by six base points in the second half of the year.

Higher Net Provision Expense Likely

First Business Financial reversed its previous positioning in each of the four quarters of 2021. Further reserve releases are likely because of the size of allowances relative to the portfolio’s credit risk. Allowances made up 1.09% of total loans while nonaccrual loans and leases made up just 0.28% of total loans, as mentioned in the earnings release. However, the reserve releases this year will likely be lower this year as the allowance level is no longer as excessive as a year-ago period. Due to the reserve releases, the allowances-to-total-loan ratio has declined from 1.30% at the end of December 2020 to 1.09% at the end of December 2021.

The loan additions mentioned above will likely drive provision expense. I’m expecting the economy to remain stable this year; therefore, I’m not expecting any worsening of the credit quality that could result in higher provisioning.

Considering the outlook on reserve releases and provision additions, I’m expecting the net provision expense to be slightly below average this year. I’m expecting the provision expense to make up around 0.26% of total loans in 2022. In comparison, the provision expense made up 0.28% of total loans in the last five years.

Expecting Earnings to Dip by 14% Year-Over-Year

The higher net provision expense will likely result in lower earnings this year relative to last year. On the other hand, loan growth and margin expansion will support the bottom line. Overall, I’m expecting earnings to decline by 14% year-over-year to $ 3.60 per share for 2022. Despite the decline, earnings for this year will still be much higher than the pre-pandemic level. The following table shows my income statement estimates.

Source: SEC Filings, Earnings Releases, Author’s Estimates

(In USD million unless otherwise specified)

FY17 FY18 FY19 FY20 FY21 FY22E
Income Statement
Net interest income 61 67 70 77 85 87
Commission for loan losses 6 5 2 17 (6) 6
Non-interest income 17 18 23 27 28 31
Non-interest expense 57 62 67 69 72 73
Net income – Common Sh. 12 16 23 17 35 30
EPS – Diluted ($) 1.36 1.86 2.68 1.97 4.17 3.60

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and the timing and magnitude of interest rate hikes.

Decent Total Expected Return Justifies a Buy Rating

First Business is offering a dividend yield of 2.5% at the current quarterly dividend rate of $ 0.1975 per share. The earnings and dividend estimates suggest a payout ratio of 22% for 2022, which is easily affordable. Therefore, the outlook of an earnings dip poses no threat to the dividend payout.

I’m using the historical price-to-tangible book (“P / TB”) and price-to-earnings (“P / E”) multiples to value First Business Financial. The stock has traded at an average P / TB ratio of 1.07 in the past, as shown below.

FY17 FY18 FY19 FY20 FY21 Average
T. Book Value per Share ($) 18.2 19.5 21.4 23.2 26.5
Average Market Price ($) 23.4 23.6 23.1 18.0 26.5
Historical P / TB 1.29x 1.21x 1.08x 0.78x 1.00x 1.07x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P / TB multiple with the forecast tangible book value per share of $ 29.3 gives a target price of $ 31.3 for the end of 2022. This price target implies a 2.6% downside from the March 21 closing price. The following table shows the sensitivity of the target price to the P / TB ratio.

P / TB Multiple 0.87x 0.97x 1.07x 1.17x 1.27x
TBVPS – Dec 2022 ($) 29.3 29.3 29.3 29.3 29.3
Target Price ($) 25.5 28.4 31.3 34.3 37.2
Market Price ($) 32.2 32.2 32.2 32.2 32.2
Upside / (Downside) (20.8)% (11.7)% (2.6)% 6.5% 15.6%
Source: Author’s Estimates

The stock has traded at an average P / E ratio of around 10.8x in the past, as shown below.

FY17 FY18 FY19 FY20 FY21 Average
Earnings per Share ($) 1.36 1.86 2.68 1.97 4.17
Average Market Price ($) 23.4 23.6 23.1 18.0 26.5
Historical P / E 17.2x 12.7x 8.6x 9.1x 6.3x 10.8x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P / E multiple with the forecast earnings per share of $ 3.60 gives a target price of $ 38.8 for the end of 2022. This price target implies a 20.6% upside from the March 21 closing price. The following table shows the sensitivity of the target price to the P / E ratio.

P / E Multiple 8.8x 9.8x 10.8x 11.8x 12.8x
EPS 2022 ($) 3.60 3.60 3.60 3.60 3.60
Target Price ($) 31.6 35.2 38.8 42.4 46.0
Market Price ($) 32.2 32.2 32.2 32.2 32.2
Upside / (Downside) (1.7)% 9.4% 20.6% 31.8% 43.0%
Source: Author’s Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $ 35.1, which implies a 9.0% upside from the current market price. Adding the forward dividend yield gives a total expected return of 11.3%. Hence, I’m adopting a buy rating on First Business Financial Services.



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