Since 2007, hurricane season has never really ended for Puerto Rico. The phaseout of U.S. subsidies for big manufacturers locating there, the financial crisis, and massive public debt—recently downgraded to junk status—have ravaged its economy.
As a proxy for the island, Popular —its biggest bank with $36.7 billion in assets—has taken a wind-lashing. It has written down assets, lurched between profit and loss, and withdrawn from Southern California, Central Florida, and Illinois. Until recently, Popular was the second-biggest remaining Troubled Asset Relief Program, or TARP, borrower. The company's shares (ticker: BPOP) have fallen 7% since August 2013, while regional banks have risen 10% and the Standard & Poor's 500 has jumped 20%. CEO Richard Carrión, 61, confides that his bank even had to foreclose on loans to members of his family, which helped found the bank in 1893.
What survived, though, is a solid franchise whose shares trade at 0.7 times book value, or about nine times 2015 earnings estimates. Comparable regional banks trade at 1.3 times book and about 12 times 2015 earnings. The discount, coupled with the island's bid to win back investment, has attracted distressed-investment specialist John Paulson, who has bought an 8.6% stake in Popular.
In a pricey banking market, Popular is "the last bastion of value investing," says Brett Rabatin, a bullish Sterne Agee analyst who has a $41 price target on the stock; that's 31% above last week's $31.30 level. "There's still a lot of skepticism embedded in the price," he says.
WITH SOME REASON. Puerto Rico has a 13% jobless rate, a high incidence of crime, and deteriorating public services. As a result, middle-income residents have been decamping, mostly for the States. Several of the U.S. territory's utilities, borrowing in the tax-exempt market, have been downgraded to less-than-investment grade in recent weeks and provide substandard services. The Puerto Rico Electric Power Authority, for instance, charges customers as much as 28 cents a kilowatt hour for power, about 2.5 times the typical U.S. rate. Barron's highlighted Puerto Rico's debt problems in a cover story last year ("Troubling Winds," Aug. 26).
But CEO Carrión reminds investors that the bank and the island aren't the same. "People tend to simplify things. Puerto Rico has been getting the wrong kind of ink. People are waiting to see if the economic crisis is going to bleed into our credit and performance," he says. But, he adds, "In so doing, they may miss opportunity."
To solidify Popular's balance sheet, Carrión has sold off the loss-making branch networks in the U.S., retreating to New York and Miami; moved more of its back-office operations to Puerto Rico; sold a clearing unit; and cut costs at its ill-starred purchase of E-Loan, an online lender. The result? Popular now has a 13.8% Tier 1 equity capital ratio, well above U.S. Bancorp's (USB) 9.6%.
Popular today is dominated by the island's Banco Popular de Puerto Rico, which represents about 60% of recent profit and nearly 75% of assets (the rest is U.S. operations). Popular offers typical retail-banking services, including mortgage origination and insurance as well as commercial lending, investment banking, and auto leasing. Wall Street estimates the bank will earn $2.84 a share in 2014, up from $2.55 in 2013, and then $3.39 in 2015.
LARGELY UNNOTICED AMONG the giant U.S. bank regulatory settlements, Popular this summer repaid its $935 million in TARP debt. That the bank did so without issuing new equity impressed Brian Klock, an analyst with Keefe, Bruyette & Woods. Popular repaid about half of the loan with cash on hand and the rest with proceeds from a $450 million, B-plus rated five-year debt offering. Convinced of the bank's profit-making ability, Klock raised his earnings estimates for 2014 to $3 a share from $2.87, and for 2015 to $3.55 a share from $3.05. The repayment could boost 2015 return on assets to 1.01%.
"Investors could be underestimating the bank's core earnings power," says Klock, who has a Buy rating on the stock. "Fear that the government fiscal situation will produce big losses is a stretch."
With the TARP money repaid, Popular is finally in a position to reinstitute a share-repurchase plan or dividend, subject to regulatory approval. It pulled its 80 cents-a-share annual dividend (3.2% effective yield) in 2009. Comparable regional banks offer a roughly 2% yield, though Popular isn't likely to give that kind of payout right away.
Popular's bulls agree that its No. 1 market position is a big competitive advantage. The bank holds 36% of all loans and 39% of all deposits on the island. Its size and clout "enable it to pick and choose among the better lending opportunities on the island," says Mark Palmer, an analyst at BGIT, who also has a $41 target.
The Bottom Line
Popular shares have trailed both the stock market and its peers in the past year. The stock could climb 30%, to more than $40, as Puerto Rico recovers.
"Our balance sheet consists of carefully underwritten businesses that are closely monitored with specific sources of repayment," says CEO Carrión. "You have to get into the weeds to really understand that a one-on-one loan is quite different from a mere piece of paper." Nonperformers are 3.3% of loans and are well reserved for.
Amid all of the talk about corporate taxes in Washington, Puerto Rico gains appeal. Despite losing some tax breaks, the island retains a strong base in manufacturing, and aims to attract more by cutting taxes on exported services to an ultralow 4%. In particular, it's seeking back-office work from financial services firms. Deutsche Lufthansa's (LHA.Germany) maintenance unit is one newcomer; it plans to open a facility next year using an abandoned U.S. airfield.
As Carrión assesses the island's status, "There are already signs we have touched bottom. The buyers are moving in. More than anything, we need new growth and fresh capital investment."
E-mail: editors@barrons.com
By Jack Willoughby Why Puerto Rico's Popular Could Jump 30%
No comments:
Post a Comment