30 October 2019

National Bank is the Only Bank to Outperform the S&P/TSX Composite (YTD)

The Globe and Mail, David Berman, 30 October 2019

Among Canada’s Big Six banks, just one is trading at a relatively high valuation: National Bank of Canada. And that gives the stock one extra hurdle to clear as the fiscal year ticks down.

Over all, the biggest banks are on a roll after rebounding from a sell-off toward the end of 2018, with average gains of 13.3 per cent year-to-date.

But National Bank, the smallest of the Big Six, stands out as the clear winner. This year, the stock is up 21.2 per cent (not including dividends), outperforming its peer average by a remarkable 7.9 percentage points.

The second-best performer, Royal Bank of Canada, is up 14 per cent. The laggard of the group, Bank of Montreal, is up just 10.9 per cent. Another way of putting National Bank’s performance into context: It is the only big-bank stock that has outperformed the broad S&P/TSX Composite Index, which is up 15.2 per cent this year.

The source of the bank’s winning ways is no mystery: National Bank is focused on Quebec, while its peers are more diversified across Canada and internationally.

In 2018, 58 per cent of National Bank’s revenue came from Quebec, compared with 29 per cent from all other provinces combined (the remaining 13 per cent of revenue came from outside Canada).

This geographic concentration is a plus when the province’s economy is humming. In July, Quebec’s gross domestic product (GDP) increased for the 10th straight month, marking the best winning streak on record for the province. GDP has risen by 3.4 per cent (at an annualized rate, after inflation) over this 10-month period, which is far better than the 1.5 per cent GDP growth nationally.

“Quebec’s economy continues to churn out historically strong growth, and remains one of the most positive economic stories on the Canadian landscape,” Robert Kavcic, senior economist at BMO Nesbitt Burns, said in a note.

The province’s economic activity has been beating the national average for nearly two years. Quebec’s unemployment rate sits at just 4.8 per cent, versus 5.5 per cent nationally. And while low energy prices have weighed on Alberta, Quebec benefits from lower energy costs.

National Bank, then, is in the right place – and it has been making the most of it. Over the past three years, the bank has produced average annual profit growth (on a per share basis) of 10.3 per cent, versus a group average of 8.9 per cent, according to CIBC World Markets.

The bank is also making strong progress in controlling costs. Its efficiency ratio, which compares expenses to profit (lower is better) improved to 53.5 per cent in the third quarter, down from 55.8 per cent in the third quarter of 2017.

The problem? The stock is no bargain.

The shares trade at 10.8 times estimated earnings, according to Bloomberg. That’s higher than the 10-year average estimated price-to-earnings ratio of 10.2, according to data last week from RBC Dominion Securities.

National Bank is the only big-bank stock with a valuation that exceeds its long-term average: The other five stocks trade at discounts. Canadian Imperial Bank of Commerce, the cheapest, has a P/E ratio of just 9.3 (again, based on estimated earnings), versus a 10-year average of 10.

Most big-bank stocks are cheap for a reason: They have been struggling to produce meaningful profit growth amid a slew of challenges. Canadians suffer from high levels of indebtedness, loan losses are rising, low interest rates are crimping lending margins and the U.S.-China trade war is muddying the global economic outlook.

The big banks’ fiscal third-quarter results, released in late August and early September, showed that profits increased just 3.7 per cent year-over-year and they were flat from the previous quarter, according to DBRS, the credit-rating agency.

Most of the banks reflect this unattractive backdrop, with relatively low valuations. National Bank is the exception, and the stock’s higher-than-average valuation could be its biggest challenge.