Monday, February 12, 2007

Canadian Banks at Highest Valuation Against US Peers

Bloomberg, Doug Alexander, 12 February 2007

The best may be over for the shares of Canada's banks after a rally that made them the most expensive in 15 years compared with their U.S. peers.

Beset by a slowing economy and fewer share sales, the six largest Canadian banks probably will see earnings rise by 10 percent in 2007 and 8.5 percent in 2008, said Brad Smith, an analyst with Blackmont Capital in Toronto. The rate was 15 percent in 2006.

``The business is obviously going to get a little rougher than it has been for awhile,'' said Stephen Jarislowsky, 81, chief executive officer of Jarislowsky Fraser Ltd., which has about a third of its $53.6 billion in financial stocks. The Montreal-based money manager pared its holdings in four of Canada's biggest banks in the fourth quarter, U.S. regulatory filings show.

Canada's top six largest banks trade at almost three times the value of their net assets, compared with 1.96 for the 24 U.S. banks in the Philadelphia Stock Exchange KBW Banks index. Based on this measure, Canadian banks became more expensive than U.S. lenders in 2004, the first time that has happened since at least 1991, according to Bloomberg data and Blackmont Capital research.

Royal Bank of Canada, Bank of Nova Scotia, Bank of Montreal, National Bank of Canada and Canadian Imperial Bank of Commerce beat all U.S. consumer bank stocks over five years, posting average annual returns of more than 17 percent since 2002, according to data compiled by Bloomberg.

Earnings for U.S. banks in the Standard & Poor's 500 Index will rise 7.2 percent this year and 9.3 percent in 2008, based on data compiled by Bloomberg.

The Bank of Canada forecast in a Jan. 18 report that the country's economic growth would slow to 2.3 percent this year, from 2.7 percent in 2006. A weaker economy will cut loan growth for the banks to 8.1 percent this fiscal year, down from 12 percent last year, and to 6.6 percent in 2008, Smith said.

Economic growth is falling off as prices for oil, natural gas and metals decline. Commodities represent 54 percent of exports and 12 percent of gross domestic product. Oil is down 28 percent, natural gas 17 percent and an index of six primary metals 14 percent from their 2006 peaks.

Mergers and new stock sales hit records in 2006. The value of mergers involving Canadian companies almost doubled to $291.6 billion last year, led by takeovers of miners such as nickel producers Inco Ltd. and Falconbridge Ltd.

Demand for initial public offerings may decline after the government announced in October it would tax income trusts for the first time. The high-yield securities accounted for a third of the record $28.4 billion in equity offerings last year that produced combined bank fees of about $1.36 billion.

Canada's six biggest banks trade for 14.3 times earnings per share on average, according to Bloomberg data, higher than the 13.4 multiple of 24 banks in the Philadelphia index. European financial shares trade at 11 times earnings.

Canadian banks' ``relative valuations are not compelling,'' compared with European lenders, said Eric Bushell, who helps manage $17 billion as chief investment officer at Signature Funds in Toronto. His firm has reduced its holdings of the five largest Canadian banks in favor of European banks.

CIBC World Markets Chief Strategist Jeffrey Rubin recommended in a Feb. 5 note that investors pare Canadian bank stocks by a half percentage point to 18.9 percent of their holdings. That's higher than the 15.9 percent weight for banks in Canada's benchmark Standard & Poor's/TSX Composite Index.

Still, the six biggest Canadian banks each posted record profits in the fiscal year ended Oct. 31, with combined net income of C$19.1 billion ($16.1 billion). The banks have increased earnings by at least 15 percent in each of the last four years, the first time they've done that in half a century, according to research by Kevin Choquette, an analyst at Scotia Capital in Toronto. Earnings growth will fall to 10 percent this year, Choquette said.

Canadian banks have a wider range of services than many U.S. companies. In addition to consumer lending, they offer investment banking, insurance and trading, and they're gaining share in the C$669 billion mutual fund market.

``Many international investors are now commenting that they missed the boat and wished they had looked at Canadian banks sooner,'' Royal Bank Chief Executive Officer Gordon Nixon said in an e-mail.

Jarislowsky Fraser bought Bank of Montreal shares even as it sold the other banks, according to the filings with the U.S. Securities and Exchange Commission.

Even with the earnings slump this year, Canadian bank stocks may fare better than their U.S. rivals, Rubin and Bushell said. The U.S. firms will be hit harder from a rise in mortgage defaults from higher-risk borrowers with low credit ratings.

Royal Bank, the country's biggest lender by assets, was the top performer among North American bank stocks, with a 21 percent average annual return, including dividends, over five years to Jan. 31. The survey covers 37 North American consumer banks with a market value of at least $8.5 billion, including Montreal-based National Bank of Canada, the country's sixth-biggest bank.

National Bank ranked second, followed by Bank of Nova Scotia, Bank of Montreal, and Canadian Imperial Bank of Commerce, all based in Toronto. Toronto-Dominion Bank, the second-largest bank, ranked 11th, the lone Canadian lender outside the top 10. Philadelphia-based Sovereign Bancorp Inc. was the best-performing U.S. bank stock, ranking sixth with a 16 percent average annual return.

``The banks have had a very good run,'' in Canada, said Marc Lalonde, who oversees $1.1 billion at Louisbourg Investments Inc. in Moncton, New Brunswick. ``There's an argument for some U.S. banks over Canadian banks - they're cheaper.''
Best Performing North American Bank Stocks Over 5 Years (US$):
Company name Country 5-year returns
1. Royal Bank of Canada Canada 20.5%
2. National Bank of Canada Canada 20.2%
3. Bank of Nova Scotia Canada 19.5%
4. Bank of Montreal Canada 17.9%
5. CIBC Canada 17.0%
6. Sovereign Bancorp Inc. U.S. 16.0%
7. U.S. Bancorp U.S. 16.0%
8. UnionBanCal Corp. U.S. 15.5%
9. Bank of America U.S. 15.2%
10. Wachovia Corp. U.S. 15.0%
11. Toronto-Dominion Bank Canada 13.8%
12. KeyCorp U.S. 13.8%