Key Takeaways for Bank of Nova Scotia Stock:
- Scotiabank (BNS) has the highest dividends among the Big Six Canadian banks but has a narrow moat and an international portfolio that entails relatively more risk.
- Since Scotiabank has around 40% of its revenue from international operations, it is one of the least exposed banks to risks stemming from a potential Canadian real estate downturn.
- We believe a potential Canadian housing downturn would impact future growth but is not an existential risk.
Andrew Willis: Last week, we looked at the most “Canadian” bank among the Big Six with National Bank and its predominantly locally sourced revenue. This week, we’re going more international – while keeping that Canadian banking advantage – and some 6.7% dividends.
Bank of Nova Scotia’s dividend yield, which is the highest among its peers, is supported by businesses in higher-growth emerging markets, primarily in Latin America. The bank does have a significant Canadian presence but it is the smallest among peers.
Equity analyst Michael Miller explains that Scotiabank’s higher international exposure gives the bank the potential for higher growth and return opportunities compared to the rest of the Big Six, but it also exposes the bank to more risks. Assessing Scotiabank’s moat as narrow, Miller adds that the bank’s international exposure has tended to be more of a headwind than a tailwind.
But going back to the bank’s Canadian exposure, if we want to talk about risks, we should also address the state of the average Canadian consumer, who has been racking up debt for over a decade now. At the centre of a potential debt-fuelled downturn, we find domestic real estate where Scotiabank has the smallest exposure to this risk, as it seeks great reward while diversifying its loan book internationally.
Scotiabank Benefits From the Canadian Banking Sector But Is Less Exposed to Local Real Estate Risks
However, as we've mentioned before, the risks from Canadian real estate on the Big Six only apply to future growth and are not existential risks in our view. From deposit insurance to mortgage insurance and what Miller describes as the implicit subsidy of being too big to fail domestically, the level of risk here may explain why local peers aren’t keeping up with Scotia’s dividend rewards.
For Morningstar, I’m Andrew Willis.
Scotiabank Bulls Say
- The Canadian market remains attractive; the government has placed barriers to entry that protect high returns.
- The international segment's exposure to higher-growth emerging markets in Latin America will offset Scotiabank's slower growth in its home markets and offer a runway for higher growth and returns compared with peers.
- Scotiabank's valuation is less demanding today. If investors can get any confidence in the bank's restructuring efforts and in the Canadian rate situation, shareholders should be rewarded.
Scotiabank Bears Say
- Higher interest rates and rising amortization periods for mortgages show the Canadian consumer is set to come under increased strain for the foreseeable future.
- The international banking segment is exposed to higher risks than the domestic segment, including risks of lower growth and higher losses, and Scotiabank's international exposure has often been more of a drag than a boost to the bank's performance historically.
- Scotiabank seems like it will have more internal investment and turnaround issues to work through than most peers for the time being.
The author or authors do not own shares in any securities mentioned in this article.
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