KBW Keefe, Bruyette and Woods analyst Mike Rizvanovic is expecting a “noisy” fourth quarter from Canadian banks to end a “challenging” year.
“For the Big Six we forecast flat EPS quarter-over-quarter, on average, and a 3-per-cent decline from last year as PCLs [provisions for credit losses] inch higher, expenses remain elevated, and revenue growth slows further,” he said. “Beyond the quarter, we continue to see a challenging environment for the group heading into F2024 with headwinds related to rising PCLs, risks around a prolonged mortgage renewal cycle, and a rate environment that could drive a deleveraging cycle in consumer lending that would curtail balance sheet growth.”
In a research report released Thursday ahead of next week’s start of the sector’s earning season, Mr. Rizvanovic said he sees a “messy” set up for the quarter, “particularly in the expense line,” and reduced his 2024 earnings per share estimates by 3 per cent for for the Big Six. He also introduced his 2025 forecasts, which imply average growth of approximately 5 per cent.
“Key themes that we expect this quarter include: 1) flattish margins in Canadian P&C Banking, downside in the U.S. lending segment, and further NIB deposit runoff, albeit at a slower pace; 2) weaker loan growth in Canada, particularly RESL, and better performance in non-domestic lending due largely to an FX tailwind from a weaker C$; 3) expense inflation with several banks impacted by severance charges; and, 4) modestly higher PCLs,” he said.
“Our F2024 estimates decline on numerous headwinds, as do our target prices, commensurately. For F2025 our newly-introduced forecasts are premised on: 1) low-single digit NII growth on weaker lending volumes and a roughly flat NIM; 2) loan loss ratios slightly elevated and only down a bit from F2024; 3) modestly positive operating leverage on the back of cost-cutting initiatives; and, 4) no share buybacks except for TD.”
With his forecast changes, Mr. Rizvanovic updated his target prices for stocks in the sector, while he reiterated Toronto-Dominion Bank as his “top-pick among the Big Six” and emphasizing EQB Inc. is “very compelling among the smaller banks” and “grossly undervalued.”
“We believe TD is well positioned to outperform its peers through F2025 as it utilizes its excess capital for buybacks and growth initiatives, which we don’t believe is currently priced into the bank’s multiple. Among the smaller banks we have a strong preference for EQB, which trades at a sizable valuation discount despite its superior medium-term growth trajectory,” he said.
The analyst raised his Street-high EQB Inc. ( “outperform”) target by $1 to $102. The average target is $95.88.
Conversely, he reduced his targets for these stocks:
- Bank of Montreal ( “outperform) to $128 from $138. Average: $126.21.
- Bank of Nova Scotia ( “market perform”) to $63 from $66. Average: $66.71.
- Canadian Imperial Bank of Commerce (“market perform”) to $56 from $58. Average: $60.30.
- Canadian Western Bank (“outperform”) to $33 from $34. Average: $32.45.
- Laurentian Bank of Canada ( “market perform”) to $28 from $33. Average: $32.27.
- National Bank of Canada ( “market perform”) to $97 from $101. Average: $100.33.
- Royal Bank of Canada ( “market perform”) to $125 from $127. Average: $134.10.
- Toronto-Dominion Bank ( “outperform”) to $94 from $95. Average: $91.26.
“As of 11/22/2023, the Big Six Canadian banks traded at a market cap-weighted forward P/E multiple of 9.6 times (on F2024 EPS consensus). That is below the group’s 10-year average multiple of 11.0 times, but a discount that we believe is justified in the current macroeconomic environment with elevated risks related to a prolonged mortgage renewal cycle in Canada. RY and TD are by far the best-valued banks at 10.4 times and 10.2 times, respectively, while CM is by far the least expensive at 8.1 times due to PCL-related headwinds (elevated CRE losses and higher volatility on performing loan PCLs). Among the smaller banks, we continue to see EQB as grossly undervalued, while CWB also trades at an outsized discount despite what we view as a solid near-term outlook. We expect valuations for the group to be range-bound in the near term with little prospect for multiple expansion,” the analyst concluded.