Being a Canadian, I try to allocate at least a portion of my portfolio towards Canadian companies. A very small part of me does this for reasons of patriotism, but more importantly I do it to at least partially avoid currency risk. Canadian investors who were fully invested in the US stock market during the past decade probably regret it being that the Canadian dollar increased in value from a low of $0.62 to par against the US dollar over that same time period. Specifically today I will be conducting an analysis of the major Canadian banks in an effort to select one as an investment candidate. The Canadian banking system is much more stable than that of the US due to tighter regulation among other things, generally pay healthy dividends, and the entire industry is in a period of growth as the Canadian economy strengthens and continues to recover from the financial crisis in 2009. Bob Johnson, a fellow Seeking Alpha author, offered an excellent summary outlining the strength and soundness of the Canadian banking industry which I encourage you to read.
Canada has six major players in its banking industry as follows:
- Bank of Montreal (BMO)
- Scotiabank (BNS)
- CIBC (CM)
- National Bank (NA)
- Royal Bank of Canada (RY)
- Toronto Dominion (TD)
All of these banks are listed on both the TSX and the NYSE, however all of the analysis that follows will be based on the TSX data/prices in Canadian dollars unless stated otherwise. First, let’s look at a quick snapshot of these companies. The following table highlights some of the fundamentals:
For each of the comparative criteria, green highlighting indicates the best, and yellow the second best. There is a large disparity in size between the largest bank (RBC) and the smallest (National), with market capitalizations of $86B and $12B respectively. All six banks pay a healthy dividend currently yielding greater than 4%, however BMO and CIBC are edging closer to 5%. Earnings growth over the past 5 years was dominated by TD at about 10.5% annually. Projected earnings growth over the next five years shows an edge for Scotiabank, however these are based on analyst consensus and all are relatively close together in the 6.5% – 8.5% range. From a valuation perspective, National Bank has both the lowest PE and PEG – significantly lower than the other companies. Finally, from a profitability standpoint, Scotiabank is head and shoulders above the rest from a profit & operating margin standpoint, while National Bank offers the best return on equity.
Looking at the above high level analysis Scotiabank seems to have an overall advantage from a growth and profitability standpoint, however National looks to be the best value while at the same time providing the best ROE.
Next let’s look at past stock performance over the past year:
As one would expect these stocks are highly correlated, however there are some observations that can be made. Notable, National and TD have lagged the other four over the past 12 months. Secondly, all banks are off of their recent highs achieved in late February by a significant margin, including a steep decline over the past week due to disappointing Canadian employment data.
Now let’s look at performance over the past five years:
Over the past five years, National was the clear winner, which could explain it’s lackluster performance recently as it may have been overbought. National is a smaller bank and as such is a bit more volatile. I am always interested in buying good value, so let’s use an additional valuation technique to determine whether any of these banks are over or underpriced at the moment. Specifically I am going to use the EPS growth capitalization method. The results are summarized in the following table:
For the above calculations I assumed a future PE of 12 for all companies and I used a discount rate of 9%. Current price, EPS (ttm), and analyst consensus estimated EPS growth rates from Yahoo Finance were used. It’s clear from the above table that National Bank appears to be quite undervalued at the moment. This is inline with the low PE ratio we noticed above. Scotiabank also looks to be slightly undervalued, while the other intrinsic values calculated are so close to today’s price that for all intensive purposes they can be treated as fairly valued. What’s interesting to note, is that these are the same two companies I identified above as being possible investment candidates.
Based on the above analysis, I will be looking to enter into a position in National Bank at or below current price levels within the next week. I will also be adding Scotiabank to my watch list with a target entry price representing a MOS of 15% below the intrinsic value I calculated above of $62.91. The represents an entry price of $47.18, which may be possible over the next few months based on the recent weakness due to unemployment.
Disclosure: I plan to take a long position in NA and BNS in the coming weeks.