Wednesday, April 26, 2006

TD Newcrest on RBC's Investor Day

TD Newcrest, 26 April 2006

Yesterday RBC hosted an Investor Day, that clearly reaffirmed in our mind the strength and growth potential of the franchise. We maintain our Buy recommendation on the stock.


Neutral. We are maintaining our 2006 EPS estimate of $3.38 and our 2007 EPS estimate of $3.70. Our 12-month target price of $54.00 remains unchanged.


RBC Canadian Personal and Business operations appear to be firing on all cylinders, with management focused on:
• Optimizing distribution,
• High return products, markets and clients, and
• Simplifying processes and structures.

Expanding distribution is a priority, with plans in place to increase:
• Client facing roles to approximately 27,000 by the end of 2006 (from 26,200 during Q1/06),
• Expand branches - over the next 5 years management are targeting to open 62 branches nationally (50 branches within the GTA over the next 3 years).
• To open another 10-15 insurance locations adjacent to branches, as initial customer response had been very positive.

Growing high return businesses is critical to RBC’s growth strategy. Again, we are impressed with RBC’s progress to date for example:
• RBC Visa’s outstanding balances increased 11% (versus the Canadian credit card market of 9%). RBC’s total market share was 16% at January 31, 2006). Visa’s purchase volumes rose 17% (versus market growth of 12%). We highlight that management is forecasting double-digit earnings growth going forward.

A key management focus is to obtain #1 or 2 market share positions for all products. At December 31, 2005, RBC achieved number 1 market share position for personal loans, cards and residential mortgages combined.

Management also commented that margins appear to stabilizing, particularly for deposits, and they believe BMO is less aggressively chasing mortgage market share.

Canadian wealth management businesses contributed 19% of total Canadian retail revenues during Q1/06. RBC Asset Management’s growth has been particularly impressive with long-term mutual funds increasing $26.7 billion since October 2002, well above its competitors.

During 2005, RBC US & International Personal and Business results have stabilized, particularly within retail banking. RBC Centura is focused on improving underlying fundamentals, and on expansion in faster growing metropolitan areas. Management indicated that progress has been made, for example:
• New branches break even quickly (20 months versus the industry average of 36 months).
• Accelerated branch openings are scheduled for 2007 - 15-20 branches will be opened in faster growing Atlanta and Florida.
• As of February 2006 there had been significant improvement in year over year key metrics, for example new personal chequing accounts opened per day increased from 1.0 to 1.56, and the cross sell ratio for new households rose from 1.0 to 1.27.

That said, clearly this franchise remains the weakling in the RBC stable of franchises. Total households serviced fell in 2005 and the bank’s rural branch positioning is less than optimal. Although management seems focused on restoring health to the operation, at some point in time, we believe an acquisition will be required to increase scale, or a disposition of the franchise will need to be considered.

Wealth management is a key business within the US franchise, contributing 2/3’s of the group’s revenues during 2005. Management is focused on organic growth, increasing sales staff and on cross selling.

Global Private Banking appears to be the key growth priority for the bank.. The bank presently operates in 21 countries and services 28,000 clients managing an average US$5.4 million per client. We highlight that ROE’s in this business are well in excess of 20%. We believe future acquisitions are likely in this area, particularly outside of North America, as this industry is considerably fragmented. Management indicated that even without acquisitions and new product introductions the business is expected to double over the next 5 years, as they are currently winning unprecedented levels of new business.


We believe RBC will deliver strong earnings growth over the next 2 years, given the bank’s superior operating momentum and dominant Canadian retail franchise and that RBC deserves a premium multiple.

Justification of Target Price

Our $54.00 target is a product of adding 50% of the $48.90 value derived from our 2007 P/E valuation of 13.5 times to 50% of the $50.74 value derived from our 2007 price-to-book valuation of 2.86 times, to which we add a premium of 8% to account for the probable change to the dividend tax legislation.

Key Risks to Target Price

We believe the key risks are: 1) unfavorable interest rate movements; 2) a downturn in the credit cycle; and 3) additional acquisitions at premium valuations.

Investment Conclusion

Yes, RBC does trade at a premium valuation to the group, at 12.7 times 2007 earnings relative to 12.1 times for the other large Canadian banks. However, no Canadian bank offers the growth profile of this institution in our opinion, which is also in the middle of its three-year efficiency plan. Management’s confidence in the future was very apparent to us. In a Canadian market that we believe lacks true leaders, we believe that RBC is clearly at the top of the pack.