D.A. Davidson Says First Merchants Trading At 11% Discount To Its Peers

D.A. Davidson has started coverage of First Merchants Corporation FRME with a Buy rating and price target of $29, implying a potential return of 16.3 percent.

"First Merchants' strategy is to be the service driven alternative to its super regional bank competitors by delivering superior service with presence close to the customers for retail banking, mortgage banking, commercial banking, and private wealth advisory services," analyst Kevin Reevey wrote in a note.

Regional Leadership

In addition, First Merchants holds leadership positions in some of the region's most attractive markets, including Indianapolis, Northwest Indiana and the suburbs of Chicago and Lafayette, Indiana, "which are expected to deliver above average population growth over the next five years.'

"We believe FRME is well positioned to capitalize on these trends given its market leadership in these regions," Reevey highlighted.

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The analyst noted, "Loan balances and deposits have grown at a CAGR of 13.9 percent and 13.2 percent since 2011. First Merchants has successfully grown its mix of noninterest DDAs from 20.6 percent of total deposits to 24.2 percent at March 31, 2016."

At the end of first quarter, NPAs were 0.78 percent of total assets, versus 0.75 percent on December 31, 2015, and down from a high of 2.40 percent at the end of 2011.

During the first quarter, the bank's NCO ratio was 0.08 percent, versus 0.04 percent in the prior quarter, and since 2011, net charge-offs have been as high as 1.25 percent.

Looking Forward

"Our earnings model assumes that NCOs tick-up from 2015 levels to 0.08 percent and to 0.10 percent in 2017 as the company charges off problem credits," Reevey noted.

For 2016, Reevey expects earnings of $1.85 a share on revenue of $303.8 million and for 2017, the analyst project EPS of $2 on revenue of $312.2 million.

The brokerage said the shares are undervalued. Based on Wednesday's close ($25.25), shares are trading at 12.6x to its 2017 EPS estimate or an 11 percent discount to its peers and 11 percent discount to its five-year average forward price-to-earnings multiple.

At time of writing, shares of First Merchants rose 1.05 percent on the day to $25.44.

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