Bank of Montreal

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Bank of Montreal is a diversified financial institution, providing a wide range of financial services including retail banking, wealth management, and investment banking, with a strong presence in North America.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Bank of Montreal (BMO) operates as a diversified financial services provider with a significant presence in North America. It has three main segments: 1. Personal and Commercial Banking (P&C): This segment provides a range of financial products and services, including banking, credit cards, and investment products, to individual and small business clients. The services are offered in both Canada and the U.S. 2. Wealth Management (Wealth): This includes wealth planning and investment solutions offered by BMO Private Wealth, and wealth management through BMO InvestorLine. 3. BMO Capital Markets (BMO CM): This segment offers investment banking, trading, and corporate banking services to corporate, institutional, and government clients.

BMO’s operations are geographically diverse with a main presence in Canada and the U.S..

Competitive Landscape

The Canadian banking sector is dominated by five large players (the Big Five): Royal Bank of Canada (RY), Toronto-Dominion Bank (TD), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CM), and BMO. These banks have created an oligopoly with each having a large share and a significant level of control, making it challenging for new entrants to become a force in the Canadian banking market. While the market in Canada is stable and predictable, intense competition has caused these banks to try growing in the U.S. market which has more variability and risk.

Moat Analysis

BMO possesses a narrow moat, scoring a 3 out of 5, based on several factors: 1. Switching Costs: BMO benefits from a degree of customer stickiness due to the costs and inconveniences associated with switching banks. Customers often rely on a complex suite of services including checking accounts, mortgages, and credit cards, making it difficult to move to another bank. Moreover, services that are integrated into the lives of its clients help retain clients and are unlikely to be moved to a new competitor. However, these switching costs are somewhat eroded by the rise of online-only banks and banking apps.

  1. Scale: As a major player, BMO has a large distribution network through branches and ATMS, as well as relationships with third party vendors. However this scale advantage may have become less effective in a world where branches and ATMs have become less important due to the digitalization of banking. Further, larger Canadian banks have a significant disadvantage when going into the US market as they face intense competition from existing banks.

Despite being one of Canada’s largest banks, BMO faces stiff competition with other big banks, hence, the company does not enjoy complete pricing power, limiting its moat.

  1. Brand Recognition: BMO has been operating for two centuries which has allowed it to garner a good brand recognition with a solid track record, especially in its home country of Canada. While a good brand does provide some competitive advantage, it isn’t as impactful as switching costs or network effect.

Moat Risks

Here are some of the risks to the moat and the business as a whole. 1. Digital disruption: Competitors that can offer simpler services that are available on the web and apps threaten BMO’s moat. Online-only banks like EQ bank with low overhead provide similar services but with no branches. Also, the rise of Fintech companies offer specific financial products at scale and will continue to erode BMO’s advantage. 2. Economic conditions: BMO is heavily influenced by macro-economic trends such as inflation, GDP, and interest rates. A recession would affect loan repayments as customers lose income, and increase the risk of defaults. Changes in the central bank policy (such as interest rates), have a significant impact on the net income that BMO can generate from its financial activities. High levels of inflation cause clients to move cash into non-depreciating assets.

BMO’s stock price has a high correlation with general economic conditions. It is best to use a long-term trend line and projections, and focus less on short term volatility. 3. Increased regulatory and capital requirements: The regulatory environment for financial firms has become more stringent and is constantly evolving, especially after the 2008 credit crisis, creating the need for banks to increase capital reserves to be able to operate safely. This would directly impact profitability and make it more difficult for companies like BMO to compete with smaller, more aggressive firms. 4. Mergers and acquisitions: If a competitor acquires a company that would increase the competitor’s scale or service portfolio, it might be a big threat to BMO. As the company itself is a result of a series of acquisitions over the last 200 years, the management of BMO are also wary of the effect of M&A on value creation (as they discussed in their 2024 Investor Day) and would be looking to pursue value creating M&A opportunities.

There is always a threat to the existing competitive landscape from any new technology or regulation coming into existence.

Financial Analysis

Here is a snapshot of BMO’s financial health and some explanation of the financial statements. 1. Revenue Distribution: A large component of BMO’s revenue comes from interest income, which has generally trended upward in a high-interest environment.

P&C banking makes up approximately 50% of total revenue and a greater portion of adjusted net income. 2. Margins: The net income margin has been quite volatile for BMO in the last two years. 3. Recent Earnings: In the latest quarterly earnings call for the period ended on October 31st, 2023, the company reported an increase in revenue from the previous quarter but a decrease in earnings. Management noted that a few factors, including the increase in provisions for credit losses, contributed to decreased profitability. They also noted that while net income increased for the year as a whole, there are potential challenges going forward related to market conditions.

Management is focused on reducing risk and improving profitability in the future. They intend to use AI, modernize their technological infrastructure, improve wealth management, and continue to grow earnings in Canada and the U.S.

     *   BMO’s net interest margin has started to fall slightly, as rates on deposits have begun to creep up, which implies that the bank may be losing its advantage on funding (they have to pay more for it).

Understandability Rating: 3 / 5

While BMO’s basic services are easy to understand, the complexities within the banking industry- regulations, interest-rate sensitivity, credit risk, and all other financial components, adds layers of obscurity. Analyzing these factors to derive an intrinsic value for BMO is tough, even for experienced investors, thus, the understandability is a 3 out of 5.

Balance Sheet Health: 4 / 5

BMO has a fairly healthy balance sheet with a stable Tier 1 Capital Ratio of 11.7%. The company also holds a sizeable amount of available cash. However, it has high loan and other debt balances, which increases the risk. In the past couple of years, the company has increased the allowance for credit losses, to offset future non-performing loans. Because there are concerns with interest rates and their impact on asset valuations, BMO’s health is scored 4 out of 5.