In a research note reviewing earnings season for the Canadian banks titled The Beat Goes On, but The Music Is Getting Harder to Dance To, Scotia Capital Meny Grauman predicted the second quarter will be “tougher” across the sector “thanks to a combination of three fewer interest-earnings days, seasonally weaker trading results, more modest margin expansion, slower loan growth and higher PCL ratios.”
“We entered Q1 reporting season concerned that the recent rally in Canadian bank stocks has been too fast and gone too far given regulatory and macro headwinds,” he said. “As a result, we continued to recommend investors favor lifecos over banks, and now that reporting season is done we have even more conviction in that relative sector call. Although all the banks we cover beat Street expectations, in most cases that was helped by better-than-expected trading revenues that we cannot assume will repeat. Heading into reporting we identified a number of focus areas for the market including margins, capital and expenses, and on all three fronts the outlook appears to be more challenging over the coming quarters. Looking ahead to Q2 more specifically, we expect a tougher quarter.”
For the first quarter, core earnings per share for the industry came in at $2.40, up 7 per cent from the previous quarter but down 2 per cent year-over-year.
“All the Canadian banks (excluding BNS) beat Street expectations, but in most cases trading was the key driver of the upside surprise,” the analyst said. “On average, results from the Big 6 Banks came in 3 per cent above consensus and 5 per cent above us (again excluding BNS). Across the board the banks painted a picture of a more challenging operating environment in the quarters ahead. We may not have hit peak margins yet, but most banks are guiding to peak margin expansion as sequential increases get smaller. When it comes to capital, most of the large banks except for NA continue to build capital (helped by discounted DRIPs) as they drive their CET1 ratios up to 12.0 per cent by year-end, which implicitly assumes another 50 bps increase in OSFI’s DSB buffer. Finally, the expense story also looks tougher than previously thought, especially in the face of slowing revenue growth. We are not hearing talk of restructuring charges, but that could change as we head into F2024.”
“Among the large banks we cover, CM and NA put up the best results of the quarter. Although NA had the highest quality beat driven by the most Q/Q margin expansion, CM’s result was notable for finally putting lingering capital concerns to rest and helping allay fears of deeper structural problems after a 19-per-cent miss to consensus in Q4. Conversely, we would rank RY at the bottom of the pack this quarter. Although EPS there beat the Street by 5 per cent, that was almost exclusively driven by trading as both margins and operating leverage disappointed. Across the group trading revenues did a lot of the heavy lifting versus consensus this earnings season, with each of the large banks we cover beating us on this line with CM and RY delivering the strongest trading results (and record Capital Market segment earnings as well). Meanwhile, the credit picture was more mixed with both BMO, CM, and NA reporting lower-than-expected PCLs numbers and BNS, RY, and TD coming in above the Street among the Big 6.”
Following the quarter, Mr. Grauman reaffirmed Bank of Montreal as his “top pick” in the sector, citing “the growth advantage it will have thanks to the recently closed Bank of the West acquisition that according to management will contribute US$2-billion in incremental PTPP earnings by the end of 2025.”
“TD is our second favorite name following our upgrade from Sector Perform to Sector Outperform this earnings season (our only ratings change during reporting),” he added. “We believe TD’s discount to the group provides investors with a unique entry point for a name that keeps outperforming on revenue growth (and operating leverage). We also believe that the risk/reward setup on capital and FHN is more positive that the market currently assumes. Alongside BMO and TD we also still have Sector Outperform ratings on RY and NA. Among the smaller banks EQB is our favorite name, and we leave earnings season with Sector Perform ratings on CWB and LB.”
His targets and ratings are currently:
- Bank of Montreal with a “sector outperform” rating and $151 target. The average on the Street is $143.74.
- Canadian Imperial Bank of Commerce with a “sector perform” rating and $66 target. Average: $65.06.
- Canadian Western Bank with a “sector perform” rating and $28 target. Average: $31.21.
- EQB Inc. with a “sector outperform” rating and $82 target. Average: $85.
- Laurentian Bank of Canada with a “sector perform” rating and $38 target. Average: $40.38.
- National Bank of Canada with a “sector outperform” rating and $111 target. Average: $107.21.
- Royal Bank of Canada with a “sector outperform” rating and $146 target. Average: $142.40.
- Toronto-Dominion Bank with a “sector outperform” rating and $104 target. Average: $101.76.