Tuesday, April 25, 2006

NBF on Cdn Banks and EVA

National Bank Financial, 24 April 2006

• EVA rose 190% in two years : EVA for the sector rose to $6.7 billion in f2005 from $2.3 billion in f2003, or an impressive 190%. Over that time, improved profitability was the most important contributing factor to the higher EVA, followed by strong business growth, particularly in f2005. A declining cost of equity capital offset, in part, the penalizing effect on EVA of greater economic capital usage. We estimate EVA was 15% lower, as a result of excess common equity balances at all banks.

• Our EVA valuation work continued to produce accurate forecasts for relative share price performance, correctly predicting the relative performance for all 6 banks in f2004.

• More modest EVA growth of 12% forecast for f2006 : For f2006, we forecast EVA to grow, albeit more modestly (up 12%) than over the previous 2 years. We forecast another year of strong business growth with further profitabilty improvements to more than offset the impact of rising capital charges stemming from higher economic capital and increased cost of equity capital.

• From an EVA valuation perspective, the sector appears to be slightly overvalued at present. Our analysis indicates that BNS, CM, NA, and TD are currently fairly valued; (i.e. their overvaluations are within 5% of their EVA implied share prices) while the other banks are either overvalued (BMO) or significantly overvalued (RY).

Rankings for f2006 (Valuation/Profitability):

1 BNS - peer-leading forecast profitability and currently fairly valued
2 CM - relatively weaker profitability, but very favourably valued
3 TD - still weakest profitability despite improvements, most favourably valued
4 NA - forecast of continued strong profitability and fairly valued
5 BMO - improved, but below average profitability forecast and overvalued
6 RY - strong forecast profitability, but significantly overvalued

^ Economic Value Added (EVA) is the financial performance measure that comes closer than any other in capturing the true economic profit of an enterprise. Put most simply, EVA is net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. As such, EVA is an estimate of true "economic" profit, or the amount by which earnings exceed or fall short of the required minimum rate of return that shareholders and lenders could get by investing in other securities of comparable risk.