ALERT: Laurentian Bank Is Still Not a Buy, Even at This Attractive Valuation

Even with a recent dividend cut, this 5% yield and attractive valuation may tempt investors in buying shares. Here’s why I’m still not ready to invest in this Canadian bank.

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The COVID-19 pandemic has created all sorts of volatility in the stock market this year. The S&P/TSX Composite Index dropped by almost 40% in just one month earlier this year. The Canadian market then rebounded with an extremely impressive run of 35% in just two months. 

The financial industry sector has been hit particularly hard this year. Each of the Big Six banks in Canada is trading below where they started this year. The COVID-19 pandemic mixed with the uncertainty in the future of the economy has largely disrupted the revenue streams of major Canadian banks. 

To date, none of the Big Six banks have cut dividends this year. Laurentian Bank of Canada (TSX:LB) on the other hand, recently cut its dividend by 40%. The quarterly dividend was reduced from $0.67 to $0.40. It’s worth noting that the regional bank still offers an impressive yield of 5% at today’s stock price. 

Will other Canadian banks follow suit?

The recent dividend cut by Laurentian Bank has many Canadian investors wondering whether other banks will do the same. 

Yes, the financial industry has been hit very hard this year, but Laurentian Bank was not in great shape prior to this economic downturn either. The bank lacked diversification in two key areas: geographic footprint and product offering.

The bank is considered to be a regional bank due to its small geographic footprint. More than 70% of the bank’s revenue is driven from east coast provinces Québec and Ontario. Making matters even worse for the bank, roughly 85% of all Canadian COVID-19 cases have come from those two aforementioned provinces. 

The lack of diversification in product offering has also not helped the bank during these volatile months this year. More than 70% of the bank’s commercial loan portfolio is tied to retail locations, construction sites, and commercial real estate. Each of those three sectors has suffered this year as the world has been practicing social distancing for months. 

Second-quarter 2020 results

The $1.5 billion bank reported its second-quarter results at the end of May. The stock price plunged on May 29 as investors were disappointed with performance from the previous quarter.

Sales of $240 million surpassed analyst expectations, but the earnings-per-share (EPS) was down significantly year over year. Diluted EPS for the most recent quarter came in at $0.13 per share, versus $0.95 in Q2 of 2019, which equates to a drop of 86% year over year. 

Attractive valuation

The one reason Canadian investors might be adding this bank to their watch list today is due to the attractive valuation.

When looking solely at the price-to-earnings ratio, Laurentian Bank is valued relatively close to each of the Big Six banks. The metric that really highlights the bank’s attractive valuation is the price-to-book (P/B) ratio.

The P/B ratio is used to measure a company’s market capitalization in comparison to its book value. Generally speaking, a low P/B ratio could mean that the company is undervalued. 

By looking solely at Laurentian Bank’s P/B ratio 0.6, all it tells us is that the bank is undervalued at today’s stock price. When comparing Laurentian Bank to the other top banks in Canada, this is where we can see how undervalued the bank really is. Only one of the Big Six banks in Canada has a P/B ratio below 1, and even that bank has a P/B ratio of 0.9.  

Foolish bottom line

It appears that Laurentian Bank has had a more difficult year than the rest of the major Canadian banks. The recent dividend cut is a direct result of these tough times. 

With a 5% dividend yield and extremely attractive valuation, I can see how Laurentian Bank might be a tempting buy today.

While I do believe that this bank will rebound in the long-term, if I’m going to be buying shares of a Canadian bank today, it won’t be shares of Laurentian Bank.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nicholas Dobroruka has no position in any of the stocks mentioned.

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