Get a 4.4% yield from cheap Royal Bank of Canada shares
Royal Bank of Canada is celebrated as a conservative, blue-chip stock offering a dependable dividend yield.
But there’s more. It has also returned our investors a massive 1,606.3% gain since we first recommended it in April 1995. That gain dramatically outpaced the 378.3% rise for the S&P/TSX Composite index.
Why buy now? Current uncertainty caused by rising interest rates and still-high inflation has prompted Canada’s big banks to increase their loan-loss provisions.
Those provisions remain well below their 2020 pandemic peaks. Still, the impact on earnings impacts valuations and that only increases the current buying opportunity.
The stock trades at modest 10.6 times forecast earnings. That’s cheap for such a solid business.
ROYAL BANK OF CANADA (Toronto symbol RY; www.rbc.com) recently agreed to pay $13.5 billion in cash for the Canadian operations of U.K.-based HSBC Holdings plc (New York symbol HSBC). That includes 130 branches, which mainly cater to businesses in industries that trade and bank internationally. HSBC also provides banking and wealth management services to over 770,000 retail clients. In all, it has total assets of $134 billion.
If Royal can win the necessary regulatory approvals, it aims to complete the purchase in late 2023. The bank expects it will cost $1 billion to integrate the new operations, but also expects to realize annual cost savings of $740 million by the end of the second year.
Due to the small size of the Canadian banking market, Royal prefers to expand internationally. For example, in 2015 it acquired Los Angeles-based City National Bank for $5.5 billion U.S. in cash and shares. City National lends to wealthy individuals as well as businesses in the entertainment, technology and health-care industries.
That acquisition is a big reason why overall revenue rose 20.5% for Royal, from $40.67 billion in 2017 to $48.99 billion in 2022 (fiscal years end October 31).
Overall earnings gained 12.5%, from $11.43 billion in 2017 to $12.86 billion in 2019; due to fewer shares outstanding, earnings per share rose at a faster rate of 15.7%, from $7.56 to $8.75.
Royal set aside $4.35 billion to cover potential loan defaults in fiscal 2020 due to the uncertainty over COVID-19; that was up 133.4% from $1.86 billion in 2019. As a result of the spike, earnings in 2020 fell 11.1% to $11.44 billion, while earnings per share declined 10.6% to $7.82.
However, Royal was reversing those provisions as the economy re-opened. As a result, earnings in 2021 jumped 40.3%, to $16.04 billion; per-share earnings rose 41.4% to $11.06. In fiscal 2022, earnings then dropped 1.5%, to $15.81 billion, or $11.06 a share (on fewer shares outstanding). The reduced profit reflected lower results in Capital Markets and Insurance, partially offset by higher earnings in Personal & Commercial Banking, Wealth Management, and Investor & Treasury Services. The current year also reflects lower releases of provisions on performing loans than a year ago.
Meanwhile, Canada’s largest bank by market capitalization earned $3.69 billion before unusual items in its fiscal 2023 second quarter, ended April 30, 2023. That’s down 12.7% from $4.23 billion a year earlier. Due to fewer shares outstanding, per-share earnings declined at a slower rate of 11.4%, to $2.65 from $2.99. That missed the $2.79 consensus estimate.
The lower earnings are mainly because the bank set aside $600 million to cover future loan losses, compared to a net credit of $342 million a year earlier.
Value Stocks: Royal Bank’s revenue is up and the earnings dip should be temporary
Earnings from Royal’s retail banking division (51% of the total) fell 14.3% due to the higher loan-loss provisions. Higher employee salaries and investments in its digital platforms also offset the benefit of higher interest rates.
As well, earnings from wealth management (20%) declined 8.3%, partly because the year-earlier quarter included a gain on the sale of a business. The Insurance division (4%) also reported 32.5% lower earnings due to a decline in the value of its investment portfolio.
However, earnings at Royal’s capital markets business (25%) improved 9.6% due to a lower tax rate and higher revenue from loan underwriting.
Overall revenue rose 20.5%, to $13.52 billion from $11.22 billion thanks to higher interest income on outstanding loans and rising insurance premiums. That also beat the $13.07 billion consensus forecast.
For all of fiscal 2023, Royal will probably earn $11.70 a share, and the stock trades at an attractive 10.6 times that forecast.
As well, with the August 2023 payment, the bank will raise your quarterly dividend by 2.3%, to $1.35 a share from $1.32. The new annual rate of $5.40 yields a solid 4.4%.
Recommendation in The Successful Investor: Royal Bank of Canada is a buy.