Monday, March 06, 2006

Scotiabank Maintained Sector Perform at RBC CM

RBC Capital Markets, 6 March 2006

BNS reported $0.85 cash EPS versus $0.82 consensus and $0.77 a year ago.

Investment Opinion

BNS’ Q1 Not Clean - Moderately Negative. Cash EPS of $0.85 beat the $0.82 consensus and was in line with our $0.86 estimate. A lower-than expected loan loss at $75MM added ~$25MM pre-tax earnings or 2¢ EPS versus consensus. Also, trading and securities gains added ~$70MM pretax or $0.02 YoY, indicating underlying EPS at ~$0.81. After adding back unusual expenses, we think underlying EPS power was ~$0.84-0.85. We are lowering our ’06 estimate by $0.13 to $3.38 and ’07 by $0.12 to $3.80. Consensus for the balance of 2006 is $0.84 per quarter.

‘Underlying’ EPS Growth Fell Short on Inflated Expenses. Eliminating YoY change in (i) loan losses, (ii) securities gains and (iii) trading revenue, BNS’ underlying EPS was up ~5%, below the 11% peer average and at the low end of Scotia’s 4-quarter trailing range of 5-10%. Expense growth was 7.2%, partly inflated by ~4¢ in non-recurring items.

Strong Relative Revenue Growth. Normalized revenue grew 8% YoY, well above the peer average of 4.5%. Excluding securities gains and trading revenue, Scotia grew revenue 5.7% to beat the peer average of 3.6%. Wholesale and wealth were the sources of revenue growth.

Domestic Retail Stalled, For Now. Domestic retail & wealth earnings were flat YoY and looked disappointing with only 3.3% YoY revenue growth versus 6.3% expense growth for operating leverage of -3%. Operating leverage declined on two non-core accounting adjustments (AcG-13 hedge mark-to-market and retiree stock-linked accruals) and other items. We are confident retail expense growth will normalize to Scotia’s naturally more disciplined course. Deteriorating retail product spreads were disappointing, though Scotia has indicated it is taking action.

Valuation. Our price target of $51 (unchanged) is set at 13.5x (up from 13x) our 2007 cash EPS estimate of $3.80. Our target P/E is set a 3% premium to our 13.1x sector target P/E to reflect Scotia’s stronger longterm growth prospects, its excess capital advantage and disciplined, focused management team. Scotia’s international operations are clearly outgrowing North American banking norms. We believe Scotia’s excess capital position, estimated at $3 billion at the end of Q106, and fast growing international growth platform offset its lower leverage to wealth and higher corporate loan exposure. Our price target is also indicated at ~2.9x our projected book value of $17.68 (as at Oct. 31/06).