Tuesday, March 07, 2006

RBC Maintained Outperform at RBC CM

RBC Capital Markets, 7 March 2006

RY’s Consensus EPS On the Rise. RBC reported well-above consensus earnings Friday and street EPS estimates should rise on the broad-based strength. Excluding a lower-than-expected loan loss, the underlying or sustainable level was ~$1.70, which on an annualized tracks in line with our $6.83 cash EPS estimate for 2006, about $0.30 above the Thomson First Call consensus of $6.50. As if to underline the sustainability of the higher earnings this quarter, RY raised its dividend by 8¢ or 12.5%.

Investment Thesis Intact. Our view that earnings estimates for RY remain too low and require upward revisions remains intact. In our view, domestic retail banking, wealth and insurance continue to demonstrate leading revenue momentum as a result of product introductions of a year ago and improving branch execution with those products. In Q1, the domestic bank grew revenue a league-leading 12.6% YoY, following on the 13.3% YoY gain last quarter. The sector average excluding RY was 6.4% this quarter and 9.3% last quarter. RY has also held expense growth sector norms to generate much better-than-average operating leverage.

High-quality earnings. RY’s 17% underlying EPS growth (ie. excluding the change in loans losses, securities gains and trading revenue) compared to the industry at 8.6% (excludes RY). In the prior 4 quarters, RY averaged 26% underlying EPS growth versus the 9% sector average.

Raising Target P/E and Price. Factoring improved EPS quality, we are raising our target P/E by a ½ multiple and reiterating our Outperform rating. Our $107 price target (up from $103) is set at 14x (up from 13.5x) our 2007 cash EPS estimate of $7.61 (unchanged). Our premium target P/E is based on high-quality EPS revisions potential, best-in-class ROE and excellent credit performance. Our price target is indicated at ~3.1x our projected book value of $34.39 (as at Jan 31/07).

Sector Valuation. Our Market Weight recommendation reflects a view that sector valuation is full. Since May 2005, the bank sector is up 22%, largely on the sharp revaluation to 14.1x from 12.2x forward consensus earnings. Our target valuation outlook at 13.1x 2007E earnings factors a 4.25% bond yield in the coming year. We expect EPS revisions will drive, indeed divide, price performance among banks in the coming year - in our view, revenue and earnings will continue to surprise on the high side for TD and RY.