Earlier this week, we talked about moat-y Canadian dividend stocks. We looked for not only a decent dividend, but also a lasting dividend – that could potentially grow. This meant that we found companies with an ‘Economic Moat’, or competitive advantage. Unsurprisingly, of the five Canadian household names that came up on our list, the top three were banks.
While bank dividends have always been strong, because of the coronavirus pandemic, dividends have not been allowed to rise. That might be set to change, as of the end of June, the U.S. Federal Reserve allowed American banks to raise dividends again. In the first week of July, most American banks announced a dividend increase.
Now, there is excitement and anticipation that Canadian banks will follow suit. “The Canadian banks should be able to raise dividends once regulators lift current restrictions. With U.S. regulators lifting their restrictions on U.S. banks entirely, we think it’s only a matter of time before Canadian regulators do likewise,” Morningstar analyst Eric Compton says.
The Backstory
Back in March 2020, the Canadian regulator the Office of the Superintendent of Financial Institutions (OSFI) suspended share buybacks and dividend increases by banks and insurers.
At the end of June, Peter Routledge took charge of the OSFI and indicated to several media outlets that he continues to be cautious about lifting the current restrictions, as a premature removal of these steps could prove to be a concern. He told the Canadian daily ‘The Globe and Mail’ that “It’s better to err on the side of keeping these restrictions on a bit too long than unwinding them a bit early.”
Despite this, there is a widespread expectation that the restrictions will lift in the second half of the year, and dividends will rise.
Morningstar analyst Compton agrees. But before we talk about the dividends, let’s look at the top 6 banks, all of which Compton has under his coverage:
|
Name |
Ticker |
Economic Moat |
Fair Value Uncertainty |
Price/Fair Value |
|
Royal Bank of Canada |
Wide |
Medium |
0.99 |
|
|
National Bank of Canada |
Narrow |
Medium |
1.00 |
|
|
The Toronto-Dominion Bank |
Wide |
Medium |
1.02 |
|
|
Bank of Nova Scotia |
Narrow |
Medium |
1.03 |
|
|
CIBC |
Narrow |
Medium |
1.07 |
|
|
Bank of Montreal |
Narrow |
Medium |
1.10 |
Morningstar Direct Data as of July 8, 2021
Banking on Growth
First, all of the banks have an economic moat. The moats of these sector leaders are supporting by a Canadian banking system and regulations that create high barriers to entry – which limits competition, stabilizes product pricing and gives consumers less incentive to switch banks.
However, an important thing to note is that none of these stocks are ‘cheap’. They’re all trading at or above our fair value estimates. With that said, let’s talk about dividends.
What About Dividends?
“None of the banks are in danger of cutting dividends, instead the question is how much will they be able to grow them. During the pandemic, bank profits held up surprisingly well, and we expect profits to continue to grow over the next several years. With a lack of dividend growth last year, this frees up payout ratios to support double-digit percentage dividend growth for most names, with potentially the exception of Bank of Nova Scotia,” Compton says.
But because none are cheap, which should you buy?
“All Canadian banks look roughly fairly valued to us at today’s prices. Royal Bank of Canada and National Bank of Canada are the cheapest, each at roughly a price-to-fair value of 1. Between the two, we think National Bank of Canada has higher growth potential and should produce higher ROEs, therefore NBC would be our top pick,” Compton says.
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