Wednesday, February 07, 2007

Citigroup Initiates Coverage of Canadian Banks

The Globe and Mail, Angela Barnes, 7 February 2007

Citigroup Global Markets Inc. has initiated coverage of the big six Canadian banks, rating three as “holds” and three as “buys.”

The three holds are Toronto-Dominion Bank, National Bank of Canada and Royal Bank of Canada and the three buys are Canadian Imperial Bank of Commerce, Bank of Nova Scotia and Bank of Montreal. The ratings vary significantly from consensus in some cases.

Citigroup analyst Shannon Cowherd gave CIBC a “buy-high risk” rating and a 12-month price target of $121. Ms. Cowherd said her rating reflects a view of the upside profit potential at CIBC, primarily driven by its cost-cutting initiative and the loan-loss coverage ratio. “We recognize the stock is up 38 per cent in seven months but feel the story is not over yet,” she said. The shares are currently trading at $101.78 on the Toronto Stock Exchange.

With Scotiabank (buy-medium risk), she noted that the shares are trading at a premium to the group, based on the forward price/earnings multiple. “We think this premium is warranted given the bank's exposure to high-growth, albeit risky, markets and our estimated three-year CAGR [compound annual growth rate] of 6.6 per cent exceeds the group average,” Ms. Cowherd said. She expects Scotia shares, which are currently stand at $51.68, will rise over the next 12 months to $64.

Ms. Cowherd noted that Bank of Montreal (buy-medium risk) shares are trading at a discount to the peer group, again based on the forward P/E. She thinks they should trade at a premium to the group. “Our recommendation is driven by our view of the upside potential for growth in both Canada and U.S. as the bank increases its risk appetite in order to generate earnings,” she said. She has a 12-month target of $85 on the shares. They are currently trading at $71.28.

In rating Toronto-Dominion a “hold” -- instead of a “buy” as most analysts have done - Ms. Cowherd argued that its shares don't deserve the premium they have because its share profit is estimated to grow by 6 per cent a year, which is in line with its peer group. “In our view, the stock will trade sideways until there is some clear indication of what shape the bank will take,” she said. That view is reflected in her 12-month price target of $73 on the shares. They stand at $70.17.

Ms. Cowherd said she doesn't see any near-term catalysts for significant share price appreciation with the Royal Bank and she thinks the premium on the shares is not warranted, given that profit is expected to grow basically in line with the group. “We believe other Canadian banks are better positioned considering our view of the operating environment over the next 12 months,” she said. “Aside from valuation, we rate the stock ‘hold' because our view is that most of the bank's strategy and earnings potential are already priced in,” she added. She expects the shares, now trading at $54.60, will rise to $59 over the next 12 months.

Ms. Cowherd describes National Bank as a niche player. Its business is being primarily driven by lending to small and medium sized enterprises and growth in the mutual fund area -- and is “firing on all cylinders,” she said. But “as the only regional player of the six and the smallest in loan, asset and market capitalization we think the opportunities for growth are somewhat limited,” she said. She has a price target of $67 on the shares that are trading at $64.70.

Ms. Cowherd's recommendations on the six banks are in some cases noticeably different from the consensus. For example, TD has been a perennial favourite in recent years and continues to be, as indicated by the eight buy ratings on it and four holds, according to Bloomberg. The consensus opinion on CIBC and Bank of Montreal is generally less favourable. There are four buys on CIBC against eight holds, and one buy on BMO against 10 holds and one sell.

She said of BMO, that the “street likely underestimates the importance of credit risk management and increased risk.”

She also said that Canadian bank valuations over all are now in line with those of U.S. banks.