Four bank stocks to deposit investment capital

These financial picks provide diversification and healthy dividends, but make sure the price is right before buying, Morningstar analyst says.

Vikram Barhat 10 November, 2015 | 6:00PM
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Economic uncertainty, oil price rout and a weak loonie notwithstanding, leading Canadian banks have posted strong profit growth in the third quarter. Similarly, banks south of the border have reported a healthy quarterly profit shored up by an uptick in job growth, consumer spending and lending activity.

After bouncing back from the 2008 financial crisis, bank stocks have continued to provide high returns in the lower-risk and highly regulated financial markets on both sides of the border. Further, North American banks have become increasingly diversified both in terms of their geographic footprint and products and services. This has afforded banks new opportunities and market shares that have helped outweigh any slowdown in one market and stay profitable, reflected by healthy dividend payouts.

There is the perception that the banks, especially those in Canada, are significantly exposed to the nation’s ailing energy sector and a dangerously frothy housing market. However, Morningstar analyst Dan Werner says Canadian banks have a limited exposure to the energy sector, and that there are no identifiable catalysts in sight that would have a negative impact upon the housing sector.

Looking at their strong fundamentals, growth trajectory and fair value, the following bank stocks appear attractive propositions for investors’ wish list. However, given the high level of uncertainty attached to their fair value, according to Morningstar equity research, investors may want to hang fire and wait for a greater discount before hitting the buy button.

Royal Bank of Canada
Ticker RY
Current yield 4.06%
Forward P/E 10.3
Price $76.20
Fair value $80
Data as of Nov. 5, 2015

 Royal Bank of Canada (RY) is the largest bank in Canada with more than $1 trillion in assets. It offers diversified financial services including personal and commercial banking, wealth management and investment banking, to 15 million clients in 46 countries.

As part of its plan to tap U.S. high-net-worth consumers, RBC recently completed a US$5-billion deal to buy Los Angeles-based bank City National Corp, its largest acquisition in history. According to a Morningstar report, RBC's capital markets segment accounts for 30% of its net income, placing the bank among the top 10 global investment banks as ranked by fees, and first in Canada. A worldwide survey conducted by The Economist last year ranked RBC as the most trusted investment bank in the world.

Morningstar equity analyst Dan Werner recently raised the stock's fair value to C$80 from C$68 while forecasting strong growth in the bank's wealth management business. As well, he projected average loan growth of 4.3% for 2015-19 and average returns on equity to increase to 20.8% by 2019 from 18% this year. RBC has raised dividends seven times for a total increase of 50% since early 2010, he added.

Ticker BMO
Current yield 4.27%
Forward P/E 10.1
Price $76.37
Fair value $94
Data as of Nov. 5, 2015

Canada's fourth-largest bank,  Bank of Montreal (BMO) serves approximately 12 million customers in Canada, the U.S. and other global markets through personal and commercial offerings, its private client group and Bank of Montreal Capital Markets.

BMO derives 43% of its net income from personal and commercial services in Canada, 18% from wealth management and 21% from capital markets. In addition to growing organically, the bank has continued to grow its wealth management and personal & commercial banking segments through acquisitions including M&I Bank in the U.S., F&C Asset Management in the UK and, most recently, General Electric Capital's transportation finance business, which prompted Werner to raise the stock's fair value to $94 from $93.

A Morningstar report forecasted the bank's net interest margin to increase from 1.65% for 2015 to 1.75% for 2018-19; it also calls for average loan growth of 5% from 2015 to 2019 and average returns on equity to increase slightly from 12.9% for 2015 to 14.1% for 2019. Bank of Montreal has increased dividends six times over the last three years, said the report.

Toronto-Dominion Bank
Ticker TD
Current yield 3.69%
Forward P/E 10.5
Price $54.34
Fair value $66
Data as of Nov. 5, 2015

 Toronto-Dominion (TD), Canada's second-largest bank, offers wholesale, personal and commercial, and wealth management services both in Canada and the U.S.

Although the share of net income from the bank's U.S. business has increased from 16% in 2009 to 28% in 2015, TD's Canadian operations continue to provide the bulk of growth, boosted by increasing commercial loan activity, producing more than 35% returns on equity.

TD will continue to deliver overall solid operating results, according to a Morningstar report that also pointed out that only about 1% of total TD loans are energy-related credits, making it among the least exposed to energy among the Canadian banks.

Werner recently upped the stock's fair value to $66 from $65 to reflect the lender's strong competitive advantage -- or wide moat -- and a weaker loonie. He predicted TD's net interest margin to grow from 2.00% in 2015 to 2.15% by 2018, and a loan growth of 5.9% for 2015-19.

Capital One Financial Corp.
Ticker COF
Current yield 1.74%
Forward P/E 10.0
Price US$80.06
Fair value US$103
Data as of Nov. 5, 2015

U.S.-based  Capital One (COF) is a diversified bank offering a broad spectrum of financial products and services to consumers, small businesses and corporations, both locally and internationally, through a growing array of delivery channels resulting from acquisitions and organic expansion. The bank, best known for its credit cards, recently agreed to buy General Electric Co.'s health-care finance unit for about US$9 billion, prompting Werner to raise the stock's fair value to US$103 from US$100.

A Morningstar report said improvement in GDP, jobs and consumer spending in the United States will spur Capital One's credit card business and further fatten its balance sheet. The report also noted that "the expansion of its automotive and commercial lending businesses will continue its solid growth during the remainder of 2015."

Werner stressed the bank's competitive advantage emanates from being a leader in the concentrated U.S. credit card market, its competitive loan pricing, the ability to localize offerings, and from the stickiness of consumer relationship.

"We project net interest margin to be 6.75% throughout our projected period [2016] as higher-yielding credit cards are expected to grow faster as the U.S. consumer begins to spend again," added Werner.

Complete access to Morningstar's research on equities, mutual funds and exchange-traded funds is available to subscribers to Morningstar Canada Premium.

Editor's note: The author owns a position in shares of Toronto-Dominion Bank.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Bank of Montreal115.60 CAD-0.84Rating
Capital One Financial Corp98.27 USD-0.67Rating
Royal Bank of Canada120.19 CAD-0.54Rating
The Toronto-Dominion Bank81.76 CAD-0.10Rating

About Author

Vikram Barhat

Vikram Barhat  A Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry, Vikram also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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