BMO. A Poster Child For Cash Flow Leverging?


I’ve been noticing that a number of bloggers - including myself - are topping up their BMO positions as the stock is rattled by commodity trading losses. Money Diva initiated 400 shares of BMO earlier in the week. My own BMO position grew to 250 shares last week with a new adjusted cost base of $63.20. BMO, to me, has the best balance of high yield and dividend growth. At $68.69, the stock is yielding a cool 3.99%, while its dividends surged from $1.20/share to $2.26/share over the past 4 fiscal years. At this price point, I think this is a window of opportunity for aggressive investors to snatch up some BMO with leverage, and still maintain a positive cash flow.

Continuing with my dividend tax calculation post, a BC resident in the 30.65% bracket wouldn’t pay any dividend taxes. If you leverage to buy BMO, you’d receive 3.99% in dividends tax-free and a small tax refund. The loan interest rate would be 5.75% from Interactive Brokers, but the interest is tax-deductible. If your tax bracket were 30.65%, your after-tax cost would be 3.99%, thus canceling the dividend yield. In other words, it’d cost you nothing to invest in BMO with borrowed money.

The reward is in the dividend growth. Granted that part of the recent growth came from rising payout ratio, but even with a modest projection of 6%/year growth, the yield can still overcome the interest rate by 1.35% in 5 years. The beauty of this setup is that you’re never forced to sell. Leveraging alone isn’t dangerous, as long as you can afford the interest.

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Comment Number:
1
Written by:
Stefan
Posted on:
May 13, 2007 at 3:34 pm

Great post!

Comment Number:
2
Written by:
moneygardener
Posted on:
May 13, 2007 at 10:44 pm

In that specific situation you described, technically it would cost you nothing above and beyond your investment cost. It would be foolish to ignore the risk that is involved though. The reward might be the dividend growth, but the risk might be further share price erosion due to one of several possible factors like intereste rate hikes, further trading losses, very slow growth etc.

Comment Number:
3
Written by:
Financial Jungle Guy
Posted on:
May 14, 2007 at 1:24 am

Thanks for the comments, moneygardner. I’m glad I qualified by saying “… window of opportunity for aggressive investors …” Although this is not a risk-free proposition, the downside risk is minimal, since BMO had already suspended ties with Optionable.

Interest rate may go up faster than dividend hike in the short-term, so investors better have some reserves just in case.

Comment Number:
4
Written by:
Investoid
Posted on:
May 14, 2007 at 1:26 pm

While there may be short term downside risk, barring any structural changes to Canadian bank regulations there is little (but definitely not 0) long term risk that BMO’s shares will be worth less than their current price in the 10-20 year time horizon.

If you are looking at the leverage play as a way to buy at a good time, and are interested in paying it back over time, then I don’t see this being a strategy that will cause undue hardship even with a short term loss. Just make sure you can cover the margin call if it ever happens.

Comment Number:
5
Written by:
Mike
Posted on:
May 16, 2007 at 2:06 am

Good post - I thought you had your numbers wrong but I didn’t realize that their dividend went up.

I’ll have to follow a bit closer since I’m about to buy some myself.

Comment Number:
6
Written by:
Financial Jungle Guy
Posted on:
May 16, 2007 at 2:19 am

I’m impressed with the dividend growth. Over the past 6 quarters, dividends were: $0.49, $0.53, $0.62, $0.62, $0.65, and now $0.68.

Comment Number:
7
Written by:
Canadian Capitalist
Posted on:
June 7, 2007 at 12:36 pm

I own positions in BNS and TD myself and if I have no exposure to banks, I’d consider BMO. But I am extremely wary about the banks here. BMO announces troubling trading losses (troubling because it raises questions about oversight. Remember Barings?) and what does the market do? It pushes the stock down by a few points. Tells me too many people are too bullish on the banks.
I own and follow BNS and TD, so this short analysis is based on reading their annual reports. I feel BMO won’t be all that different.
In the five year period between 2001-2006, BNS’s revenue has barely budged (TD’s is up 10%). But earnings (and hence dividends) have surged dramatically. The magic: smaller credit loss provisions. The entire growth in BNS earnings can be attributed to the improving credit cycle. This is an unsustainable situation and the credit cycle will surely turn sometime in the future (don’t ask me when).
I remember reading an interview with Ed Clark (TD’s chief) in The Globe last year and he commented that he can’t recall a time when conditions were so favorable for the banks (falling interest rates, a credit cycle that keeps improving) etc. If anything, conditions have gotten even better now.

Comment Number:
8
Written by:
Canadian Capitalist
Posted on:
June 7, 2007 at 12:38 pm

I meant to add this to the last comment:
The question is how long will this happy situation last?

Comment Number:
9
Written by:
Financial Jungle Guy
Posted on:
June 7, 2007 at 4:18 pm

I hear you. The double-digit dividend growth is not sustainable moving forward, so I’m concentrating on safety, valuation and conservative growth. I think a case can be made that BMO’s dividends are safe, because banks don’t normally raise dividends in anticipation of a cut, and a 4% yield is attractively, or at the very least, not overpriced.

All banks trade. I like BMO’s case, because they have been exposed, while others haven’t. The $600 millions trading loss (pre-tax) pales when compared to the $17 billions on balance sheet. Alas, it would’ve been nice to hop in if there was an over-correction.

ps. I’m noticing the market has been struggling the past few days. Might want to prepare a shopping list.

Comment Number:
10
Written by:
Financial Jungle - » Jungle Bulletin: You Give A Little Love And It All Comes Back To You
Posted on:
June 19, 2007 at 7:57 am

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