01 March 2006

RBC CM's Preview of Scotiabank Q1 2006 Earnings

RBC Capital Markets, 1 March 2006

BNS reports Q1/06 earnings on March 3. We are looking for cash EPS of $0.86 versus the Thomson First Call mean estimate of $0.82.

Investment Opinion

Expecting BNS to Beat Consensus. Our Q106 estimate would drive 11% YoY growth. We have factored revenue growth at +10% YoY, still up +9% excluding securities gains. Last quarter the bank delivered +11% core revenue growth, and +13% excluding the drag of foreign exchange translation. However, investors were spooked in Q405 by Scotia’s indicated earnings miss after excluding $0.03 for a general loan loss release and ~$0.03 for higher-than-run-rate securities gains. The apparent EPS miss was largely owing to a Q4 expense bulge that we believe related to year-end accruals, and which we believe are unlikely to repeat in Q106. For example, BNS expensed a large investment in product capacity for its Scotia Inverlat operation in Mexico, pre-paid certain 2006 marketing expense items to save costs, and boosted its litigation reserves for which we are not aware of any unusual items forthcoming.

Credit Expected Steady. We are forecasting a $107MM (normalized) loan loss provision (0.23% of L&A) this quarter, compared to $81MM (normalized, $36MM reported including a general reserve release) in Q05 and $74MM a year ago. Last quarter, the normalized LLP was roughly in line with expectations. We modeled a modest decline in gross impaired loans to $1.8B, indicating a continued stable trend. The coverage ratio is expected to remain essentially flat sequentially at 146%, and remains below the group average of ~164% this quarter (excluding TD).

Above-Consensus Outlook for 2006/2007. For the full year 2006, we are carrying a well-above-consensus EPS outlook for BNS. Our $3.51 EPS estimate for 2006 is 3% above 2006 consensus, while our $3.92 estimate for 2007 is 7% higher than consensus. Our thesis is that BNS will manage loan losses in the range of 0.22% of loans in 2006, and 0.30% in 2007, below and better than consensus, some 10% higher on loan losses.

Valuation. Our price target of $51.00 (unchanged) is set at 13x our 2007 cash EPS estimate of $3.92. Our target P/E is in line with the target P/E multiple for the group and slightly above Scotia’s five-year average discount of 2%. We believe Scotia’s excess capital position, estimated at $2.8B at the end of Q4, and fast-growing international growth platform offset its lower leverage to wealth and higher corporate loan exposure. Our price target is indicated at ~2.9x our projected book value of $17.68 (as at Oct. 31/06).