Friday, August 25, 2006

Outlook High for RBC as Peers Storm Out of Gate

The Globe and Mail, Allan Robinson, 25 August 2006

Third-quarter bank earnings have been stronger than expected so far, and it will take stunning results for Royal Bank of Canada just to keep pace.

Even more problematic for shareholders in RBC, which holds top spot among Canada's biggest corporations and accounts for nearly 5 per cent of the total market capitalization for the S&P/TSX, is that the stock is trading at a premium to its peers based on 2007 earnings forecasts.

This week both Toronto-Dominion Bank and Bank of Montreal reported third-quarter profit growth of 92 per cent and 30 per cent, respectively, which was well above the 11-per-cent forecasts.

Growing comfort with the earnings outlook has resulted in the S&P/TSX financial index jumping 6 per cent in less than two weeks.

Analysts forecast Royal Bank's share profit will increase almost 11 per cent to 84 cents during the third quarter, from 76 cents a year earlier, according to Thomson First Call.

The bank's profit for fiscal 2006 is forecast at $3.44 a share. The shares closed unchanged yesterday at $50.70 on the S&P/TSX.

Investor expectations for RBC are high and a shrinkage in the price-to-earnings multiple is a risk, given its exposure to a potential slowdown in the capital markets and trading activity, said Robert Wessel, an analyst with National Bank Financial Inc.

Analysts are split as to whether RBC will be able to maintain its superior growth rate. Of the 12 analysts following the company, six rate it a "buy" and six a "hold," according to Bloomberg.

RBC's dominant domestic retail banking and wealth management businesses helps to justify the 5-per-cent to 10-per-cent premium at which its shares trade compared to its peers, said Mario Mendonca, an analyst at Genuity Capital Markets in a recent report.

The bank has also been willing to buy back shares -- in June it filed a proposal to buy back up to seven million shares by the end of fiscal 2006 -- and increase its dividends, he said.

During the third quarter, the bank repurchased 5.5 million shares.

The bank's current dividend payout ratio of 39 per cent on a year-to-date basis is below the bank's target payout of 40 per cent to 50 per cent and suggests it could "deliver an impressive 22-per-cent, year-over-year increase in the quarterly dividend this quarter," Mr. Mendonca said. RBC has a five-year dividend growth rate of 15.6 per cent, according to Bloomberg.

Over all, the Canadian banking industry is also keeping a close check on the credit quality of its loans, which is keeping loan-loss provisions down, analysts say.

Analysts have been catching up to the underlying earnings power of RBC, which should keep the price-to-earnings multiple from expanding, Mr. Mendonca said. "Throughout 2005 and in the first quarter of 2006, Royal Bank routinely delivered earnings that were well ahead of consensus," he said. But during the second quarter, estimates were only slightly below reported earnings.