Monday, June 11, 2018

Scotiabank's 2017-2018 Acquisition Binge

  
The Globe and Mail, David Berman, 11 June 2018

Bank of Nova Scotia’s acquisition binge is weighing on its share price amid concerns about the bank’s ability to digest new assets valued at a whopping $7-billion.

But while some analysts are growing nervous about the stock and slashing their outlook, contrarians should see the recent turbulence as a gift.

You can certainly understand why Scotiabank’s pace of deal-making is drawing attention: Five deals in seven months mark the bank’s most significant streak of takeovers in recent memory.

In terms of dollar totals, the recent spending spree is equal to seven years’ worth of previous deals, which included the takeovers of ING Bank of Canada in 2012 and DundeeWealth Inc. in 2010.

Scotiabank, which has been focusing on its substantial international operations in Mexico, Chile, Colombia and Peru, kicked off its latest deal-making in late November, 2017, when it announced a $2.9-billion deal for a 68-per-cent stake in BBVA Chile.

In January, Scotiabank announced a $435-million deal to acquire Citibank’s retail and small-and-medium sized business operations in Colombia. In February, it snapped up Jarislowsky Fraser Ltd., the Montreal-based independent investment firm, for $950-million.

In early May: a $130-million deal for a 51-per-cent stake in Peru’s Banco Cencosud. And near the end of May, Scotiabank announced an agreement to acquire MD Financial Management, an Ottawa-based wealth management operation that caters to doctors, for nearly $2.6-billion.

In yet another financial transaction, the bank closed a $1.7-billion equity offering last week to help fund the latest deal – its first public offering in nearly six years.

Analysts acknowledge that the deals are consistent with Scotiabank’s regional focus and interest in expanding its wealth management operations. But the hefty prices paid, along with some concerns that deals are being struck when the economic cycle may be nearing a peak, have driven some notable downgrades.

On Monday, RBC Dominion Securities lowered its recommendation on the stock to “sector perform” from “outperform” – its first downgrade in four years − and cut its target price on the stock to $86 from $95 previously.

The brokerage said the downgrade was a response to “heightened execution risk, dilution, and uncertainty related to several acquisitions.”

It added: “Scotiabank has deployed upwards of $7-billion of capital at very high prices that require significant synergy to create value for shareholders. It is our view that synergies are far from certain and most likely far into the future.”

National Bank Financial also lowered its recommendation to “sector perform” and cut its target price to $85 from $88.

To be fair, these are just two killjoys compared with 10 upbeat analysts who recommend the stock as a “buy.” But the dimmer outlook, at a time when Scotiabank’s share price is down more than 6 per cent year-to-date and trailing all of its Big Six peers, must make some investors wonder whether the shares are best avoided.

Near term, they may be: If there are additional downgrades, investor sentiment is going to be challenged, especially if economic ripples undermine the value of the bank’s financial assets.

Longer term, though, an underperforming bank stock should excite investors – and Scotiabank is no exception.

Why? Scotiabank completed its equity offering last week at a price of $76.15 a share, 10 per cent below the stock’s record high but hardly a distressed sale. Indeed, given that the shares are up 35 per cent since the start of 2016, you could argue that the bank is tapping the market at a time of strength – which is smart.

Second, the stock’s valuation is compelling. According to Bloomberg, the shares trade at 10.8 times estimated earnings – a bargain next to Royal Bank of Canada, Toronto-Dominion Bank and Bank of Montreal, and well below its 10-year average valuation. Perhaps concerns about Scotiabank’s acquisitions weighing on the bank’s profitability are already factored into the share price.

And lastly, as I've noted before, today's underperforming bank stock tends to be tomorrow's outperformer. Okay, not literally tomorrow, but big Canadian banks have an uncanny ability to catch up within a year or so.

Scotiabank is lagging its peers. But for nimble investors, this can be good news.

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