The Globe and Mail, Carolyn Leitch, 5 September 2006
Rich valuations on bank stocks and a gloomier profit picture have prompted Merrill Lynch Canada Inc. analyst André-Philippe Hardy to cut his rating on National Bank of Canada to "neutral" from "buy."
Mr. Hardy also lowered his estimate for National Bank's profit in 2007 to $5.30 a share from his previous forecast of $5.40.
The analyst says National Bank's provision for credit losses is low compared with its historical rate and with other banks, although he adds that credit data do not suggest that problems with bad loans are imminent.
At the same time, retail customers are not signing up for mortgages and increasing their credit card balances as quickly as they are at rival banks, Mr. Hardy says.
Mr. Hardy says he supports National Bank's relatively conservative strategy compared with some of its peers, which is why mortgage and credit-card growth is slower.
Still, with price-to-earnings ratios on bank stocks now at an average of 12.6 -- about 1.3 times higher than their average of the past five years -- Mr. Hardy finds valuations quite high. National Bank trades at a multiple of about 11.4, which marks a discount to the group in line with the average of the past five years.
He does not expect that gap to narrow given the profit headwinds the bank faces.
Rich valuations on bank stocks and a gloomier profit picture have prompted Merrill Lynch Canada Inc. analyst André-Philippe Hardy to cut his rating on National Bank of Canada to "neutral" from "buy."
Mr. Hardy also lowered his estimate for National Bank's profit in 2007 to $5.30 a share from his previous forecast of $5.40.
The analyst says National Bank's provision for credit losses is low compared with its historical rate and with other banks, although he adds that credit data do not suggest that problems with bad loans are imminent.
At the same time, retail customers are not signing up for mortgages and increasing their credit card balances as quickly as they are at rival banks, Mr. Hardy says.
Mr. Hardy says he supports National Bank's relatively conservative strategy compared with some of its peers, which is why mortgage and credit-card growth is slower.
Still, with price-to-earnings ratios on bank stocks now at an average of 12.6 -- about 1.3 times higher than their average of the past five years -- Mr. Hardy finds valuations quite high. National Bank trades at a multiple of about 11.4, which marks a discount to the group in line with the average of the past five years.
He does not expect that gap to narrow given the profit headwinds the bank faces.
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Scotia Capital, 1 September 2006
Third Quarter Earnings Increase 6% - Relatively Weak
• National Bank (NA) Q3/06 operating earnings were $1.25 per share, an increase of 6% versus $1.18 per share a year earlier, driven by very high security gains, partially offset by weaker trading revenues. Earnings were relatively weak, with the growth rate the lowest of the bank group.
• Reported earnings were $1.30 per share which included a $0.05 per share gain on the MasterCard IPO.
• Security gains (excluding the MasterCard IPO) were very high at $0.19 per share which is $0.12 per share above the average over the last 12 months. The higher sec
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Third Quarter Earnings Increase 6% - Relatively Weak
• National Bank (NA) Q3/06 operating earnings were $1.25 per share, an increase of 6% versus $1.18 per share a year earlier, driven by very high security gains, partially offset by weaker trading revenues. Earnings were relatively weak, with the growth rate the lowest of the bank group.
• Reported earnings were $1.30 per share which included a $0.05 per share gain on the MasterCard IPO.
• Security gains (excluding the MasterCard IPO) were very high at $0.19 per share which is $0.12 per share above the average over the last 12 months. The higher sec
urity gains were partially offset by lower trading revenues.
• Earnings growth was driven by a 17% increase in Wealth Management earnings and 11% increase in Financial Markets earnings with modest growth of 5% in Personal & Commercial Banking.
• Return on risk-weighted assets was 1.69% versus 1.76% a year earlier. Operating ROE was 19.4%, versus 19.6% a year earlier.
Personal & Commercial Banking Earnings Increase Modestly
• Personal and Commercial Banking (P&C) earnings increased 5% year over year to $122 million (excluding the gain on MasterCard IPO), with solid growth in personal and commercial loans.
• Revenues in the P&C segment increased 4% to $546 million, with increases in all sectors, with a particularly large increase in insurance revenues. Expenses increased 5% year over year to $339 million.
• Securitization revenue was $38 million in the quarter down from $48 million a year earlier.
Retail NIM Improves 3 bp in the Quarter
• Retail net interest margin (NIM) improved 3 basis points (bp) in the quarter to 2.89% due to higher deposit margin.
Wealth Management Earnings Increase 17% YOY
• Wealth Management earnings were $34 million, an increase of 17% YOY.
• Revenue grew 3% YOY to $204 million, with particular strength in mutual fund revenues which increased 13% YOY. Expenses increased a modest 1% resulting in an improved efficiency ratio.
Financial Markets Earnings Increase 11%
• Financial Markets earnings increased 11% YOY to $60 million from $54 million a year earlier, driven by high security gains, partially offset by weaker trading revenues.
• Operating leverage was high at 5% with revenue increasing 7% driven by very high security gains and an increase in corporate banking revenues. Expenses increased a modest 2% due to a reduction in variable compensation.
Trading Revenue Weak
• Trading revenue was low at $67 million versus $86 million in the previous quarter and $106 million a year earlier. Commodities trading revenue was particularly weak at $1 million versus $12 million in the previous quarter. The bank cited its trading desk move from Houston to Calgary as a reason. Also, natural gas prices were extremely volatile in the quarter.
Capital Markets Revenue Decline
• Capital Markets revenue declined to $139 million from $164 million in the previous quarter and from $158 million a year earlier due to lower contribution from managed retail products.
Investment Security Gains High
• Security gains were very high at $47 million or $0.19 per share, excluding the gain on the MasterCard IPO, compared to $28 million or $0.11 per share in the previous quarter and a loss of $7 million or $0.03 per share a year earlier. The bank booked a $13 million or $8.5 million after tax or $0.05 per share gain on the MasterCard IPO. The total security gains were $60 million in the quarter.
Unrealized Security Deficit
• Unrealized security surplus moved to a deficit of $28 million versus a surplus of $33 million in the previous quarter and a surplus of $131 million a year earlier. Unrealized equity security surplus was $10 million versus $80 million in the previous quarter and $60 million a year earlier.
Total Revenue & Expenses Increase 3%
• Total bank operating leverage remained flat with both revenues and expenses increasing 3% year over year to $975 million and $634 million.
• The efficiency ratio was 65.0% versus 64.9% a year earlier.
Loan Loss Provisions Remain Very Low
• Loan loss provisions (LLPs) were $16 million or 0.12% of loans, compared to $22 million or 0.17% of loans in the previous quarter and $15 million or 0.12% of loans a year earlier.
• LLPs in P&C Banking were $24 million with $1 million in Financial Markets and a recovery in the "other" segment of $9 million. The recovery in other segment added $0.04 per share to earnings.
• We are lowering our 2006 LLP estimate to $75 million or 0.14% of loans from $90 million or 0.17% of loans. We are also reducing out 2007 LLP estimate to $120 million or 0.23% of loans from $130 million or 0.25% of loans.
• Gross impaired loans (GILs) were $214 million in the quarter versus $242 million in the previous quarter and $261 million a year earlier.
Tier 1 Capital Ratio
• Tier 1 ratio was 9.4%, compared to 9.2% a year earlier. During the quarter, the bank issued $225 million in innovative capital instruments.
• The common equity to risk-weighted assets ratio (CE/RWA) was 8.8% versus 8.9% a year earlier.
Recent Management Changes
• On July 27, NA announced the appointment of Louis Vachon as COO of the company. Priorto this appointment, Louis Vachon was Senior Vice-President, Chairman and Chief Executive Officer of National Bank Financial Group.
• On August 31, NA announced the appointment of Ricardo Pascoe and Luc Paiement as Co-Presidents and Chief executive officers of National Bank Financial Group. Mr. Pascoe will be responsible for all activities related to institutional equities and fixed income securities, derivatives, U.S. operations and treasury. Mr. Paiement will be responsible for retail brokerage services, Corporate Banking, Investment Banking and Research.
Earnings Estimates
• We are increasing our 2006 earnings estimate slightly to $4.97 per share from $4.95 per share. Our 2007 earnings estimate remains unchanged at $5.35 per share.
• Our 12-month share price target remains unchanged at $72, representing 14.5x our 2006 earnings estimate and 13.5x our 2007 earnings estimate.
• Maintain 2-Sector Perform rating.
• Earnings growth was driven by a 17% increase in Wealth Management earnings and 11% increase in Financial Markets earnings with modest growth of 5% in Personal & Commercial Banking.
• Return on risk-weighted assets was 1.69% versus 1.76% a year earlier. Operating ROE was 19.4%, versus 19.6% a year earlier.
Personal & Commercial Banking Earnings Increase Modestly
• Personal and Commercial Banking (P&C) earnings increased 5% year over year to $122 million (excluding the gain on MasterCard IPO), with solid growth in personal and commercial loans.
• Revenues in the P&C segment increased 4% to $546 million, with increases in all sectors, with a particularly large increase in insurance revenues. Expenses increased 5% year over year to $339 million.
• Securitization revenue was $38 million in the quarter down from $48 million a year earlier.
Retail NIM Improves 3 bp in the Quarter
• Retail net interest margin (NIM) improved 3 basis points (bp) in the quarter to 2.89% due to higher deposit margin.
Wealth Management Earnings Increase 17% YOY
• Wealth Management earnings were $34 million, an increase of 17% YOY.
• Revenue grew 3% YOY to $204 million, with particular strength in mutual fund revenues which increased 13% YOY. Expenses increased a modest 1% resulting in an improved efficiency ratio.
Financial Markets Earnings Increase 11%
• Financial Markets earnings increased 11% YOY to $60 million from $54 million a year earlier, driven by high security gains, partially offset by weaker trading revenues.
• Operating leverage was high at 5% with revenue increasing 7% driven by very high security gains and an increase in corporate banking revenues. Expenses increased a modest 2% due to a reduction in variable compensation.
Trading Revenue Weak
• Trading revenue was low at $67 million versus $86 million in the previous quarter and $106 million a year earlier. Commodities trading revenue was particularly weak at $1 million versus $12 million in the previous quarter. The bank cited its trading desk move from Houston to Calgary as a reason. Also, natural gas prices were extremely volatile in the quarter.
Capital Markets Revenue Decline
• Capital Markets revenue declined to $139 million from $164 million in the previous quarter and from $158 million a year earlier due to lower contribution from managed retail products.
Investment Security Gains High
• Security gains were very high at $47 million or $0.19 per share, excluding the gain on the MasterCard IPO, compared to $28 million or $0.11 per share in the previous quarter and a loss of $7 million or $0.03 per share a year earlier. The bank booked a $13 million or $8.5 million after tax or $0.05 per share gain on the MasterCard IPO. The total security gains were $60 million in the quarter.
Unrealized Security Deficit
• Unrealized security surplus moved to a deficit of $28 million versus a surplus of $33 million in the previous quarter and a surplus of $131 million a year earlier. Unrealized equity security surplus was $10 million versus $80 million in the previous quarter and $60 million a year earlier.
Total Revenue & Expenses Increase 3%
• Total bank operating leverage remained flat with both revenues and expenses increasing 3% year over year to $975 million and $634 million.
• The efficiency ratio was 65.0% versus 64.9% a year earlier.
Loan Loss Provisions Remain Very Low
• Loan loss provisions (LLPs) were $16 million or 0.12% of loans, compared to $22 million or 0.17% of loans in the previous quarter and $15 million or 0.12% of loans a year earlier.
• LLPs in P&C Banking were $24 million with $1 million in Financial Markets and a recovery in the "other" segment of $9 million. The recovery in other segment added $0.04 per share to earnings.
• We are lowering our 2006 LLP estimate to $75 million or 0.14% of loans from $90 million or 0.17% of loans. We are also reducing out 2007 LLP estimate to $120 million or 0.23% of loans from $130 million or 0.25% of loans.
• Gross impaired loans (GILs) were $214 million in the quarter versus $242 million in the previous quarter and $261 million a year earlier.
Tier 1 Capital Ratio
• Tier 1 ratio was 9.4%, compared to 9.2% a year earlier. During the quarter, the bank issued $225 million in innovative capital instruments.
• The common equity to risk-weighted assets ratio (CE/RWA) was 8.8% versus 8.9% a year earlier.
Recent Management Changes
• On July 27, NA announced the appointment of Louis Vachon as COO of the company. Priorto this appointment, Louis Vachon was Senior Vice-President, Chairman and Chief Executive Officer of National Bank Financial Group.
• On August 31, NA announced the appointment of Ricardo Pascoe and Luc Paiement as Co-Presidents and Chief executive officers of National Bank Financial Group. Mr. Pascoe will be responsible for all activities related to institutional equities and fixed income securities, derivatives, U.S. operations and treasury. Mr. Paiement will be responsible for retail brokerage services, Corporate Banking, Investment Banking and Research.
Earnings Estimates
• We are increasing our 2006 earnings estimate slightly to $4.97 per share from $4.95 per share. Our 2007 earnings estimate remains unchanged at $5.35 per share.
• Our 12-month share price target remains unchanged at $72, representing 14.5x our 2006 earnings estimate and 13.5x our 2007 earnings estimate.
• Maintain 2-Sector Perform rating.
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TD Newcrest, 1 September 2006
Event
NA reported operating EPS of $1.25 (excluding a Mastercard IPO gain of $0.05), just ahead of our estimate and consensus of $1.24, up from $1.23 in Q2/05 and $1.18 in Q3/05. Overall results were solid, but not as impressive as others in the group this quarter, due to weaker than expected wealth management and trading results.
Impact
Slight Negative. We are maintaining our BUY recommendation and 2006 and 2007 EPS estimates of $5.05 and $5.60 respectively. We are, however, lowering our target price to $69.00 (from $71.00).
Details
Strong retail results, with net income of $130 million, up from $111 million in Q2/06 (partly due to 3 extra days in the quarter), and $119 million a year ago. Overall, the division reported excellent results ahead of our estimates.
• Margins improved sequentially. NIM’s were 2.89%, up from 2.86% in Q2/06, but still down from 2.94% a year ago.
• Asset growth was reasonable, although lower than others within the group, with average loans and BA’s increasing 7.5% year over year to $47 billion. Personal loans were the biggest contributor, up 9% year over year.
• Credit losses and operating expenses were well contained.
Wealth management results were reasonable, but slightly below our estimates. Net income of $34 million, was down sequentially, but up 13% year over year.
• Strong AUA and AUM growth, up 16% from Q3/05.
• Mutual fund momentum continued.
• Lower transactional business caused the decline in earnings sequentially. Financial Market earnings were in line with expectations, with net income of $60 million, up slightly from $59 million in Q2/06 and Q1/06 respectively.
• Higher gains on securities (which included a $13 million gain from the sale of the bank’s position in Hedgestone ), were principally offset by reduced trading revenues year over year.
• Trading revenues were disappointing at $68 million, down 18% sequentially and 36% year over year. Management indicated that this was partly due to moving energy trading operations from Houston to Calgary, and partly due to taking more prudent trading positions.
Credit remained strong, with PCL’s improving to $16 million from $22 million last quarter and $15 million a year ago. Gross impaired loans remained low at $214 million.
Tier 1 capital increased to 9.4% (at the lower end of the bank group) from 9.1% at April 30, 2006. No shares were repurchased during the quarter although the bank issued $225 million in innovative capital instruments. We highlight, that YTD management has been aggressive in returning capital to shareholders through a combination of dividends and share buy backs.
Valuation
NA is currently trading at 10.7 times estimated 2007 earnings, versus the rest of the peer group, which is trading at 12.3 times 2007 earnings. We are forecasting EPS growth of 10% and 11% in 2006 and 2007 respectively, and given NA’s earnings growth projections, we believe NA should at least trade in line with the group.
Justification of Target Price
Our $69.00 NA target price is a product of adding 50% of the $66.97 value derived from our 2007 P/E valuation of 12.6 times to 50% of the $71.84 value derived from our 2007 price-to-book valuation of 2.5 times.
Key Risks to Target Price
We believe that the four key valuation risks specific to NA that may prevent the stock from attaining our target price are: a) Unfavorable interest rate movements; b) Quebec sovereignty (we view this with a low probability); c) Lack of scale and financial flexibility; and d) Irrational pricing behavior from non-public competitor Desjardins.
Investment Conclusion
NA reported a steady quarter, beating consensus estimates by $0.01. Unfortunately, the bank suffers in comparison to most other Canadian banks, which generally significantly beat consensus. Like the other banks, NA reported very good retail & commercial banking results, however, weaker than expected trading, wealth and corporate profitability acted as an offset.
Without a visible earnings growth catalyst, we admit that it’s hard to get too excited about buying NA’s shares. That said, the bank is consistently growing its business and delivering improving results. While earnings growth wasn’t as impressive as the other banks, we believe this discrepancy is fully reflected in NA’s share price, which is trading at a 1.6 times multiple discount to the group. We believe the stock should be very attractive to value investors that also appreciate reasonable, consistent growth. We maintain our Buy on the stock, but have slightly reduced our target price to $69.00, to reflect our slight disappointment with the performance of the wealth and trading operations.
Event
NA reported operating EPS of $1.25 (excluding a Mastercard IPO gain of $0.05), just ahead of our estimate and consensus of $1.24, up from $1.23 in Q2/05 and $1.18 in Q3/05. Overall results were solid, but not as impressive as others in the group this quarter, due to weaker than expected wealth management and trading results.
Impact
Slight Negative. We are maintaining our BUY recommendation and 2006 and 2007 EPS estimates of $5.05 and $5.60 respectively. We are, however, lowering our target price to $69.00 (from $71.00).
Details
Strong retail results, with net income of $130 million, up from $111 million in Q2/06 (partly due to 3 extra days in the quarter), and $119 million a year ago. Overall, the division reported excellent results ahead of our estimates.
• Margins improved sequentially. NIM’s were 2.89%, up from 2.86% in Q2/06, but still down from 2.94% a year ago.
• Asset growth was reasonable, although lower than others within the group, with average loans and BA’s increasing 7.5% year over year to $47 billion. Personal loans were the biggest contributor, up 9% year over year.
• Credit losses and operating expenses were well contained.
Wealth management results were reasonable, but slightly below our estimates. Net income of $34 million, was down sequentially, but up 13% year over year.
• Strong AUA and AUM growth, up 16% from Q3/05.
• Mutual fund momentum continued.
• Lower transactional business caused the decline in earnings sequentially. Financial Market earnings were in line with expectations, with net income of $60 million, up slightly from $59 million in Q2/06 and Q1/06 respectively.
• Higher gains on securities (which included a $13 million gain from the sale of the bank’s position in Hedgestone ), were principally offset by reduced trading revenues year over year.
• Trading revenues were disappointing at $68 million, down 18% sequentially and 36% year over year. Management indicated that this was partly due to moving energy trading operations from Houston to Calgary, and partly due to taking more prudent trading positions.
Credit remained strong, with PCL’s improving to $16 million from $22 million last quarter and $15 million a year ago. Gross impaired loans remained low at $214 million.
Tier 1 capital increased to 9.4% (at the lower end of the bank group) from 9.1% at April 30, 2006. No shares were repurchased during the quarter although the bank issued $225 million in innovative capital instruments. We highlight, that YTD management has been aggressive in returning capital to shareholders through a combination of dividends and share buy backs.
Valuation
NA is currently trading at 10.7 times estimated 2007 earnings, versus the rest of the peer group, which is trading at 12.3 times 2007 earnings. We are forecasting EPS growth of 10% and 11% in 2006 and 2007 respectively, and given NA’s earnings growth projections, we believe NA should at least trade in line with the group.
Justification of Target Price
Our $69.00 NA target price is a product of adding 50% of the $66.97 value derived from our 2007 P/E valuation of 12.6 times to 50% of the $71.84 value derived from our 2007 price-to-book valuation of 2.5 times.
Key Risks to Target Price
We believe that the four key valuation risks specific to NA that may prevent the stock from attaining our target price are: a) Unfavorable interest rate movements; b) Quebec sovereignty (we view this with a low probability); c) Lack of scale and financial flexibility; and d) Irrational pricing behavior from non-public competitor Desjardins.
Investment Conclusion
NA reported a steady quarter, beating consensus estimates by $0.01. Unfortunately, the bank suffers in comparison to most other Canadian banks, which generally significantly beat consensus. Like the other banks, NA reported very good retail & commercial banking results, however, weaker than expected trading, wealth and corporate profitability acted as an offset.
Without a visible earnings growth catalyst, we admit that it’s hard to get too excited about buying NA’s shares. That said, the bank is consistently growing its business and delivering improving results. While earnings growth wasn’t as impressive as the other banks, we believe this discrepancy is fully reflected in NA’s share price, which is trading at a 1.6 times multiple discount to the group. We believe the stock should be very attractive to value investors that also appreciate reasonable, consistent growth. We maintain our Buy on the stock, but have slightly reduced our target price to $69.00, to reflect our slight disappointment with the performance of the wealth and trading operations.
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Merrill Lynch Downgrades National Bank
The Globe and Mail, Roma Luciw, 1 September 2006
Merrill Lynch Canada Inc. analyst André-Philippe Hardy downgraded National Bank of Canada to “hold” from “buy” Friday on the basis it is getting pricey and that average profit growth at the bank will slow next year.
Canada's big six banks now trade at 12.6-times forward earnings, 1.3-times above their five-year average which took place at a time when credit losses were declining, capital markets were strong, and the retail loan business was growing.
At this time, the outlook for banks is less rosy. “We expect earnings growth to slow for the group,” Mr. Hardy said.
However, the analyst expects National to post core income growth of 2 per cent in 2007, compared with 8 per cent for the remainder of the five large banks.
National Bank faces earnings headwinds greater than those facing other banks, Mr. Hardy said, and sales growth could be disappointing. For one, National's security gains were high in the third-quarter while personal and consumer loans were unsustainably low.
“Retail loan growth has slowed in Quebec due to increased competition, and the company's successful partnership programs with wealth management firms are not large enough yet to offset slower growth in the bank's base market,” Mr. Hardy said.
He cut his 2007 earnings target by 10 cents to $5.39 a share, saying the new forecast reflects higher estimated PCLs and lower capital markets sales.
Montreal-based National Bank, the sixth-largest in Canada, reported a 6 per cent rise in third-quarter profit yesterday. Earnings rose to $220-million - its best quarterly result so far this fiscal year — on strong results in asset management and personal and commercial segments.
Shares of National Bank have fallen 0.6 per cent so far this year in Toronto.
The Globe and Mail, Roma Luciw, 1 September 2006
Merrill Lynch Canada Inc. analyst André-Philippe Hardy downgraded National Bank of Canada to “hold” from “buy” Friday on the basis it is getting pricey and that average profit growth at the bank will slow next year.
Canada's big six banks now trade at 12.6-times forward earnings, 1.3-times above their five-year average which took place at a time when credit losses were declining, capital markets were strong, and the retail loan business was growing.
At this time, the outlook for banks is less rosy. “We expect earnings growth to slow for the group,” Mr. Hardy said.
However, the analyst expects National to post core income growth of 2 per cent in 2007, compared with 8 per cent for the remainder of the five large banks.
National Bank faces earnings headwinds greater than those facing other banks, Mr. Hardy said, and sales growth could be disappointing. For one, National's security gains were high in the third-quarter while personal and consumer loans were unsustainably low.
“Retail loan growth has slowed in Quebec due to increased competition, and the company's successful partnership programs with wealth management firms are not large enough yet to offset slower growth in the bank's base market,” Mr. Hardy said.
He cut his 2007 earnings target by 10 cents to $5.39 a share, saying the new forecast reflects higher estimated PCLs and lower capital markets sales.
Montreal-based National Bank, the sixth-largest in Canada, reported a 6 per cent rise in third-quarter profit yesterday. Earnings rose to $220-million - its best quarterly result so far this fiscal year — on strong results in asset management and personal and commercial segments.
Shares of National Bank have fallen 0.6 per cent so far this year in Toronto.
