Amid forecasts that Canadian economic growth will continue to be slow, this may be a good time to take a look at Canadian sectors that have performed steadily. One such sector is financial services.
The Canadian banking industry, in particular, has fared remarkably well despite the threat of energy-loan losses and the risk of a significant downturn in the housing market. Canadian lenders have strong growth prospects both at home and abroad.
Strict regulation and a primarily conservative culture have made Canada's financial system the envy of the world. In fact, to cite a PwC report, the World Economic Forum has ranked Canada's banks the soundest in the world for the last eight years.
For investors, too, Canadian banks tick many boxes. They are becoming more diversified both in terms of their geographic footprint and products and services. They are profitable, pay generous dividends and have balance sheets that can withstand the impact of economic and geopolitical events with relative stability.
Investors looking for long-term opportunities in their own backyard may find particularly attractive prospects in certain banks trading well below their fair value, according to Morningstar equity research.
| Bank of Montreal | ||
| Ticker | BMO | |
| Current yield | 3.91% | |
| Forward P/E | 11.2 | |
| Price | $84.57 | |
| Fair value | US$94 | |
| Data as of Oct. 4, 2016 | ||
Bank of Montreal (BMO) is Canada's fourth-largest bank with nearly 12 million customers in Canada, the United States and other global markets. The company operates four business segments: personal and commercial (Canada), personal and commercial (U.S.), the private-client group and Bank of Montreal Capital Markets.
"Bank of Montreal's operations span both its Canadian high-return banking and capital-markets operations along with lower-return, but growing, U.S. banking businesses," says a Morningstar report, noting that the bank generates 43% of its net income from personal and commercial services in Canada, 19% from wealth management and 21% from capital markets.
The bank's potential for organic growth is further supported by the acquisition-led expansion of its wealth management, and personal and commercial-banking segments. "Over the past year, lending growth has been solid at Bank of Montreal, with some growth in residential lending as a result of low mortgage rates, but primarily in commercial lending, which has long been a competency for the bank," says Morningstar sector director Stephen Ellis, who put the stock's value at $94 and projected average loan growth of 5.3% from 2016 to 2020.
Morningstar projects the bank's net interest margin to increase from 1.6% for 2016 to 1.65% for 2017-2020; and returns on equity to rise slightly from 11.9% for 2016 to 12.7% for 2020. Bank of Montreal, says Ellis, has increased dividends multiple times over the past three years.
| Bank of Nova Scotia | ||
| Ticker | BNS | |
| Current yield | 4.15% | |
| Forward P/E | 11.1 | |
| Price | $69.98 | |
| Fair value | $78 | |
| Data as of Oct. 4, 2016 | ||
Canada's third-largest bank, Bank of Nova Scotia (BNS) has more than $850 billion in assets and operates four segments: Canadian banking, international banking, global wealth and insurance, and global banking and markets. As Canada's leading international bank, it provides financial services to 21 million customers across more than 55 countries in South America, Mexico, Asia and the Caribbean.
"Scotiabank has consistently demonstrated its ability to earn high returns through a variety of channels over a long period," says a Morningstar report, adding that its "overall capital generation has been resilient."
The bank's third-quarter net income improved for all segments versus the second quarter. Canadian banking reported a 7% jump in deposits, while international banking reported strong loan growth of 9% and deposit growth of 15%. "The (international banking) segment continues to enjoy tailwinds, with favourable currency translations and strong organic balance sheet growth," says Ellis, who appraised the stock's value to be $78. "The segment's exposure to higher-growth emerging markets in Latin America and Asia will offset Scotiabank's slower growth in its home markets."
The Canadian market remains attractive for domestic banks, he adds, with high returns protected by the barriers to entry put in place by the federal government.
| Canadian Imperial Bank of Commerce | ||
| Ticker | CM | |
| Current yield | 4.7% | |
| Forward P/E | 10.0 | |
| Price | $100.42 | |
| Fair value | $119 | |
| Data as of Oct. 4, 2016 | ||
Canadian Imperial Bank of Commerce (CM) is Canada's fifth-largest bank with more than $450 billion in assets and 11 million clients worldwide. Focused on Canada, CIBC provides a range of financial products and services through three business units: retail and business banking, wealth management and wholesale banking.
Sidestepping the impact of falling commodity prices and anemic economic recovery, CIBC beat market expectations by reporting a third-quarter profit of $1.4 billion, up 47% from last year.
A Morningstar report says that while the lender's credit exposure to the energy sector is higher than that of other Canadian banks, it is sharpening its focus on improving profitability through personal and commercial banking, its largest and most important operating segment. CIBC, says the report, is also "working to change its culture to become 'relationship focused' in attaining and retaining clients rather than just selling products."
The wealth-management segment also is a priority for growth. "CIBC wants to generate a greater proportion of its income from the lucrative, fee-based business, which now constitutes only 13% of net income," says Ellis. "(The move) will help to diversify revenue streams and minimize any impact from credit cycles."
More recently, CIBC has been successful in organically growing assets under management, supported by stronger sales of long-term mutual funds. "We would not be surprised by an acquisition from CIBC adding assets under management from this segment," says Ellis, who pegged the stock's value at $119.
| National Bank of Canada | ||
| Ticker | NA | |
| Current yield | 4.69% | |
| Forward P/E | 9.4 | |
| Price | $46.19 | |
| Fair value | $58 | |
| Data as of Oct. 4, 2016 | ||
With more than $200 billion in assets and three operating segments -- Canadian banking, wealth management and financial markets -- National Bank of Canada (NA) is the smallest of major Canadian banks. Although it competes almost exclusively in Canada, with a large proportion of its business concentrated in Quebec, the Montreal-based lender is aiming to generate 10% of profit from its global business by 2020.
CEO Louis Vachon is reported to have said at the bank's recent international development investor day: "We are looking to complement our Canadian growth -- not substitute, but complement our Canadian growth -- with a disciplined international strategy that delivers higher returns."
The bank's third-quarter profit of $478 million, up from $453 million last year, handily beat market forecasts. National Bank wants to be more than just a Quebec bank. This focus is reflected in the growth in revenue from outside the province, which, as a share of total revenue, has grown to 40%, up from 33% in 2011, says a Morningstar report.
The personal and commercial-banking segment comprises nearly half of the lender's net income. Yet, it's pivoting increasingly toward fee-based business in wealth management and financial markets. As part of that strategy, the bank has over the years acquired "Wellington West Holdings and the advisory business of HSBC Securities (Canada), as well as TD Waterhouse Institutional Services, which has solidified its position as a leading provider of securities-processing services," says Ellis.
Investors looking for value will find it in the more than 20% discount at which the stock is trading relative to its fair value of $58, as estimated by Morningstar. Also, a dividend yield of 4.6% is nothing to sneeze at.
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