Canada’s financial industry appears to be dusting itself off after a spectacular double-digit fall last year sparked by a savage sell-off of Canadian bank stocks. The weakness, however, brought valuations down making some of these stocks the cheapest in a decade. Add enticing dividends to the mix and these lenders become attractive buys for long-term investors. On average, major Canadian banks are each paying a nearly 4% dividend, far exceeding bond yields that have dropped below 2% this year.
There is plenty going for these banks. For a start, they operate in an oligopoly that holds nearly 90% of the banking deposits.
Also, as a group, they have clocked robust profit growth and have consistently raised dividends despite the sector and economic turmoil. History shows that resilient banks have always bounced back from bouts of weakness.
Robust capital reserves, growing revenue and profits, solid balance sheets, and diversified businesses and global presence conspire to create a long runway of growth for these lending institutions.
Investors looking for attractive prospects in their own backyard will find compelling options in the following names trading meaningful below their fair value, according to Morningstar equity research.
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Royal Bank of Canada |
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Ticker |
RY |
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Current yield: |
3.93% |
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Forward P/E: |
10.98 |
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Price |
$99.98 |
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Fair value: |
$111 |
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Value |
10% discount |
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Data as of January 30, 2019 |
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The Canadian banking behemoth, Royal Bank of Canada (RY) has more than $5 trillion of assets under administration and over $650 billion of assets under management. Royal Bank’s sustainable competitive advantage is built on superior operating efficiency, leading market share, moaty nonbank businesses, and a favourable Canadian banking environment, says a Morningstar equity report.
“It has done an admirable job of expanding its nonbank lines of business, running efficient banking operations, and generating some of the best returns for shareholders in the industry,” the report says, noting that “with strong global capital markets operations, and a dominant share of domestic banking operations, it should remain one of the dominant Canadian banks for years to come.”
“We expect Royal Bank of Canada to remain a steady player in its retail and commercial Canadian banking operations,” says Morningstar equity analyst, Eric Compton, who points out the bank also “remains a major player in global capital markets, experiencing tremendous growth over the past several years.”
On the wealth-management side, RBC remains a dominant player with the largest amount of assets under management in Canada, adds Compton, who recently raised the stock’s fair value from $109 to $111.
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The Toronto-Dominion Bank |
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Ticker |
TD |
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Current yield: |
3.64% |
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Forward P/E: |
10.6 |
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Price |
$73.75 |
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Fair value: |
$81 |
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Value |
9% discount |
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Data as of January 30, 2019 |
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The second of Canada’s two largest banks, Toronto-Dominion (TD) is unwavering with its focus on its Canadian retail operations, that have helped it grow into number-one or -two market share for most key products in this segment, while gaining number-two market share for business banking in Canada. “With roughly $370 billion in assets under management, top-three dealer status in Canada, and as the number-one card issuer in Canada, Toronto-Dominion should remain one of the dominant Canadian banks for years to come,” says a Morningstar report.
The bank’s wide moat, or sustainable competitive advantage, stems from superior market share in the advantageous Canadian banking environment, a better deposit mix, and exposure to moaty nonbank businesses.
TD Bank has also carved a formidable presence in the U.S. where it has the most branches among Canadian banks along with a 42% ownership stake in discount brokerage TD Ameritrade. “We also like Toronto-Dominion’s positioning as a major discount-brokerage player because we believe this industry is ripe for growth as investors seek out lower-cost alternatives,” says Compton.
The bank’s fourth-quarter earnings report showed a 10% net income growth in Canadian retail segment and a 17% year over year jump in earnings per share, prompting Compton to note, “there were no signs of deterioration in the Canadian mortgage portfolio.”
Home equity loans, he added, continued to soar at a fast clip, and given the current Canadian real estate market environment, “this is a key portfolio to keep a close eye on.”
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Bank of Montreal |
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Ticker |
BMO |
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Current yield: |
4.12% |
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Forward P/E: |
12.11 |
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Price |
$97.46 |
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Fair value: |
$105 |
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Value |
8% discount |
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Data as of January 30, 2019 |
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Bank of Montreal (BMO) is Canada’s fourth-largest bank and is more commercially focused in Canada with a sizeable share of the domestic commercial lending market. “Additionally, BMO has the lowest relative exposure to residential mortgage loans among its peers, helping to mitigate some of the risks within its loan book,” says a Morningstar report, but cautions that “a true housing crisis could cause a recession and hurt commercial loans indirectly.”
The lender has been bulking up its U.S. presence over the past several years where its commercial lending is expected to grow at a high-single-digit rate. “We like BMO’s presence in the U.S., as it has built up respectable deposit market share numbers and has avoided some of the mistakes other Canadian banks have made in attempts to expand south,” says Compton
However, it’s the bank’s Canadian operations, particularly the more moaty nonbank businesses, such as its asset-management operations, that provide competitive advantage. “BMO has the second-largest amount of assets under management among the Canadian banks, with the largest proportion of its revenue coming from wealth-management fees among peers,” says Compton, who pegs the stock’s fair value at $105.
