Valuation: Undervalued

Investment Thesis:

With the recent spike in the 10-year yields worrying some investors and multiple stimulus bills being passed, printing money quicker than ever before, there is a constant worry amongst investors about rising inflation.
- To take advantage of this fact we need to find a stock/sector that outperforms the market when inflation rates rise.
When inflation rises, regional banks enjoy an increase in their interest spread, this helps to increase the profit margins, which causes them to outperform the market during situations where inflation increases.
My investment valuation and plan imply an upside of 35.99%, this will result in the price increasing from $15.66 (current price) to an estimated price of $21.29.

Company Overview:

Hope Bancorp provides banking services to small and medium sized businesses, as well as individuals in the United States. Hope Bancorp offers personal and business checking/savings accounts, money market, time deposits, and individual retirements accounts.

Hope Bancorp offers the following commercial loan products: business loans, real estate loans, small business administrative loans, consumer loans (mortgage, auto, credit etc.), and personal loans.

Hope Bancorp also offers trade financial services such as the issuance/negotiation of letters of credit, documentary collections, warehouse lines of credit, and commercial equipment lease financing.

Hope Bancorp also offers cash management services, which include remote deposit capture, investing/asset management, mobile banking, debit card, foreign exchange, safety deposit boxes, and many more.

Hope Bancorp has 58 branches in California, Washington, Texas, Illinois, New York, New Jersey, Virginia, and Alabama. Furthermore, Hope Bancorp has SBA loan offices in Seattle, Denver, Dallas, Atlanta, Portland, Oregon, New York, California, and Houston.

Investment Information:

Macroeconomic Outlook:

With the recent spike in the 10-year yields worrying some investors and multiple stimulus bills being passed, printing money quicker than ever before, there is a constant worry amongst investors about rising inflation.

However, when inflation rises there are certain sectors that outperform the market, one of these sectors being regional banks. This is largely due to the fact that when interest rates are up, these banks can charge more interest on the loans that they give out, and their interest spread increases, having a positive effect on their margins. This is especially important for regional banking stocks as increasing interest rates tend to help the regional banks more so than the large/diversified banks.

I am not a time traveller (I know it might be hard to believe), however interest rates are bound to increase back to their usual levels at around 2-2.5%, which would imply an increase of 23.15-53.94% (from the current yield of 1.62%). I do not know when the rates will recover to this benchmark (because once again I am no time traveller) but it is bound to happen eventually (likely in the next couple of years.

So, finding a high quality, and undervalued (both in terms of cash flows, and when comparing it to other banks) regional bank, will help you to achieve the best return when interest rates return to their natural levels.

Source:

Regional Bank Stocks Rise as Bond Yields Climb - WSJ

Financial Information:

Net Interest income (before provision for credit losses) is up 2% QoQ, to $122.6M
- 3^rd consecutive quarter of net interest income growth.
Net income increased 54% QoQ to $43.7M
Non-interest-bearing deposits increased 13% QoQ
- Record high level for Hope Bancorp
Time Deposits increased 11% QoQ
Credit losses continued to be very small
- $2.1M in credit losses (0.06% of loans receivable)
Diversified mix of loans totalling $847M.
- 55% Commercial and Industrial (C&I) loans.
- 37% Commercial Real Estate (CRE) loans
- 8% consumer loans
The average interest rate on their loans has increased by 5.2% QoQ
- Rates increased from 3.27% (Q4 2020) to 3.44% (Q1 2021)
Non-interest income decreased by 22.8% QoQ
- This is due to fees they paid on swaps, and a decrease in deposit service fees from check cashing.
Net gain on the sale of mortgage loans increased by 31.25% QoQ.
Hope Bancorps deposit costs have decreased by 73.13% YoY
- 34% (Q1 2020) to 0.36% (Q1 2021)
- This should help to increase Hope Bancorp’s margins
Hope Bancorp has a strong liquidity position of approximately $5B

Some of the most important information from this section is their net income increasing by 54% QoQ, the average interest rate on their loans increasing by 5.2% QoQ, their net gain on sale of mortgage loans increasing by 31.25% QoQ, and their deposit costs decreasing 73.13% YoY. These are all very important because they contribute to larger revenues and better profit margins. These factors will all contribute to making Hope Bancorp’s earnings report better and entice more investors into opening positions in their company. Furthermore, if Hope Bancorp is able to maintain these trends, then it is very likely that my DCF will be understating the fair value of $HOPE.

Company Information:

Hope Bancorp has set out a near-term outlook which consists of:
- Loan growth (forecasting a 5-9% growth rate).
- Gain-on-sale Income.
- Decrease Noninterest Expenses (improve their cost management).
- Increasing their net interest margin by further decreasing deposit costs.
- Lower their provision for credit losses to enhance profitability
- Maintain sound management of credit, capital, and liquidity.

Valuation Information:

WACC:

I found Hope Bancorp’s WACC through a website called finbox in which they showed their calculations and how they arrived at their figure. They arrived at a WACC of 8.75%.

CAGR:

In order to find the CAGR I calculated Hope Bancorp’s average EBIT growth rate over the past 2 years, which turned out to be 11.97%. Then I found a CAGR on a website called Tracktak, which they calculated to be 10.13%. However, there is a small discrepancy between these numbers, so I averaged the two figures to arrive at a CAGR of 11.05% for my DCF model.

Interest Expense Growth Rate:

When looking at Hope Bancorp’s financials I noticed that their interest expense figures were very volatile but generally fell between the same range of numbers, so I decided to take their average interest expense over the past 10 years and took it as a constant (no increase or decrease).

Tax Rate:

I was able to find Hope Bancorp’s effective annual take rate in their most recent 10-K filing. They reported their tax rate to be 21.60%.

Investment Valuation and Plan:

Valuation:

In order to value Hope Bancorp ($HOPE), I performed both a DCF analysis and a comparable analysis.

DCF:

In order to come to a fair value through a DCF model, I used the information found in the “Valuation information” section. The DCF model that I conducted shows an implied upside of 35.99%, which would translate to a share price of $21.29. This upside is quite reasonable, however in order to validate this estimate I underwent a comparable analysis to see if there was any correlation.

Comparable:

The Comparable analyses that I decided to undergo include P/B, P/S, and P/E. The main comparable that I was looking at was their P/B. This is because in banks and insurance companies, most of their value sits in their book value. This multiple gives analysts the best price estimates for these types of companies. I also decided to do the P/E and P/S to give me more context as the EV multiples were not available for many regional banks.

P/B:

Based off of the P/B comparable, the estimated fair value of Hope Bancorp is $24.18, which implies an upside of 54.41%. This is a bit more bullish than the DCF model, however they are relatively consistent, and both confirm that $HOPE is indeed undervalued.

P/S:

Based off of my P/S comparable, the fair value of $HOPE is $20.44, which implies an upside of 30.52%. This is a bit close (and less bullish) than the DCF model, however once again it confirms the value in a stock like $HOPE.

P/E:

The P/E multiple is quite standard for investment analysts to use, with that being said my P/E comparable estimated an implied upside of 24.39% or a price per share of $19.48. Once again this is somewhat consistent with the DCF model and the other comparable.

Average Comparable:

The average price estimate from the 3 comparable analyses is $21.37 which implies an upside of 36.46%, this is within 8 cents of the DCF model. This is very good for me as an analyst to see because it shows consistencies in valuation which helps me to have conviction in the valuation and investment.

Plan:

Any entrance into a position in $HOPE under $17 will help you to limit the downside risk, while leaving enough potential upside for the investment to make sense and be worth your time and money.

I would sell my whole position once the price reaches the $21.29 level achieved in the DCF.

This plan (assuming you buy at the current price of $15.66) implies an upside of 35.99%.

Catalysts:

Increases in the inflation rate and 10-year yield
- These increases will increase the share prices whenever there is a sizeable jump, and it will increase slowly as these rates increase slowly back to their usual percentages.
Meeting their near-term goals (should be reported in quarterly reports or investor presentations)
- This will reflect higher growth rates and bigger profit margins which can help investors see the value in this company.

Risks:

If the inflation rate and 10-year yield stay relatively near where they are now.
- This is very unlikely, but nothing is impossible, so I am not discounting this possibility
- This will keep the stock where it is or even decrease the price as investors might sell their positions (because they bought in with the expectation of increased inflation)

Portfolio Reasoning:

This stock fits in perfectly with the portfolio idea/thesis
- Undervalued
- Small-Cap
- Can take advantage of macroeconomic trends (ie. Increasing inflation) to accelerate share price growth.
Helps to diversify this portfolio to mitigate risk.
- I have one stock in the insurance sector, which is somewhat related to banking, however regional banks operate quite differently than diversified (big) banks.
Counterbalances my portfolio
- As inflation increases this stock will increase, however my previous stock addition ($MHO) will decrease as inflation increase.
  - This helps to further mitigate the risk and make this portfolio safer.