Lakeland Financial’s Earnings To Come Under Pressure – Lakeland Financial Corporation (NASDAQ:LKFN)

Earnings of Lakeland Financial Corporation (LKFN), a bank holding company, are expected to decline due to a reduction in net interest margin and increase in non-interest expense. However, the pressure on the bottom-line is expected to be partly offset by loan growth. Despite the prospects of earnings decline, quarterly dividends are expected to be maintained at the current level, providing a decent dividend yield of 2.73%.

Loan Growth to Slow

LKFN operates solely in Indiana and focuses on the commercial loan segment; therefore, its loan growth depends on business sentiment and economic growth of the state. Indiana’s economy has fared worse than the rest of the nation from 2Q2018 till 1Q2019. The state’s GDP growth was recorded at 2.9%, as opposed to the national average of 3.1% in 1Q2019. Not every aspect of Indiana’s economy is below average, however, as the state’s unemployment rate is better than the national average, as shown in the chart below.

Data by YCharts

Due to global trade uncertainties I’m expecting United States’ economic growth to slow down, and Indiana’s economic growth to follow suit. This in turn will cause LKFN’s loan growth to decline. I’m expecting LKFN’s loan book to grow by 1.5% in the remainder of 2019, and 3.0% in 2020.

Lakeland Financial Corp Balance Sheet Forecast

Decline in Net Interest Margin to Drag Earnings

LKFN’s net interest margin, NIM, is expected to decline in the remainder of 2019 and in 2020 due to the 50bps Fed rate cut in 2019 till date. However, the effect of the rate cut on NIM is expected to be somewhat dampened by favorable funding and loan mix.

The company’s funding mix is low cost, which will help NIM in the future. LKFN keeps costs under control by successfully funding organic loan growth through core deposits, thereby reducing the need for expensive funds. As mentioned in the 2QFY19 investor presentation, deposit growth outpaced loan growth in 2018 and 1H2019.

Further, a favorable loan mix is expected to limit the decline in NIM. Fixed rate commercial loans, which made up 31% of LKFN’s total loans as at June end 2019, will soften the impact of the 50bps Fed Funds rate cut on average yields. According to the 2QFY19 presentation, fixed rate commercial loans portfolio carried an average term of 5 years.

Due to the above mentioned factors, I expect NIM to decline by 10bps in both the third and fourth quarters of 2019, and by 6bps in 2020 (average for the year will be 17bps below the average for 2019). My estimates are shown in the table below.

Lakeland Financial Corp Net Interest MarginMy expectations are mostly in line with the management’s guidance given in the 2QFY19 investor presentation. The management expects a 50bps rate cut to reduce net interest income by 3.67%. The graph below, which has been taken from the presentation, shows the results of the simulation conducted to determine sensitivity of net interest income to interest rate movement.

Lakeland Bancorp Simulation Net Interest Income

Non-Interest Expense To Further Pressurize Earnings

Apart from NIM, LKFN’s earnings are also expected to get pressurized by non-interest expense. LKFN’s continued focus on investment in technology, as is evident from the 2QFY19 presentation, is likely to keep non-interest expense on the upwards trajectory. Combining the effects of low loan growth, decrease in net interest margin, and increase in non-interest expense gives an overall decline in earnings. I expect LKFN’s earnings per share to decline by 5% in 2020 to $3.12, as shown in the table below.

Lakeland Financial Corp Income ForecastDividends Likely to be Maintained

Despite the prospects of earnings decline, I’m expecting LKFN to maintain its quarterly dividend at the current level throughout 2020. My expectation of dividend maintenance is mostly attributable to a comfortable level of payout ratio, of 38.4% in 2020. Further, LKFN’s Tier I ratio of 13.33% at the end of June 2019 was above the minimum regulatory requirement of 6.0% (for capital adequacy purposes), thereby minimizing the need to cut dividends.

The dividend estimate of $0.30 per share every quarter translates to a dividend yield of 2.73% for 2020.

Valuing at $48.2

I’m using the historical average price to book multiple, P/B, of 1.94 to value LKFN. The trend of the P/B ratio is shown in the table below.

Lakeland Financial Corp Historical Price to Book

Multiplying the average P/B ratio with the forecast book value per share of $24.9 gives a December 2020 target price of $48.2, which implies a 9.8% upside from LKFN’s October 16, 2019 closing price.

Lakeland Financial Corp Valuation Sensitivity

Conclusion: Adopting Neutral Stance

As my target price implies a potential price upside of less than 10%, I’m adopting a neutral stance on LKFN. I’m also recommending buying the stock if its price dips to 10% below the target price, i.e. $43.85.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.