National Bank Financial analyst Gabriel Dechaine expects shares of Bank of Nova Scotia to remain range-bound until investors see the results of a strategic review aimed at improving net interest margins and return on equity. Scotiabank dropped 5.7 per cent on Wednesday following the premarket release of its first-quarter financial results, including core cash earnings per share of $1.85 that fell well below the Street’s forecast of $2.02. Lower-than-anticipated revenue and higher expenses drove the miss.
“The market clearly had a negative reaction to BNS’ Q1/23 results,” said Mr. Dechaine. “More importantly, we believe it could remain under pressure until investors have a clearer picture of BNS’ strategic direction. Key strategic messages included accelerating deposit growth (and likely moderating loan growth) in order to improve margins, and improved risk-adjusted returns in certain International banking regions (namely Colombia and Central America). In our view, the trade-offs being contemplated involve lower revenues against higher margins and ROE. However, until investors can quantify the net upside of these tradeoffs, the stock will likely be range-bound until these items are clarified at BNS’ Investor Day, which is expected to be hosted by the end of calendar 2023.”
Mr. Dechaine expects expense growth to “moderate” in the near term and also sees the bank “easily” hitting a 12-per-cent Common Equity Tier 1 (CET 1) ratio by the end of the year.
“NIX [non-interest expenses] was 4 per cent above our forecast, with Q1/23′s NIX growth rate of 6 per cent above the 3-per-cent pace set during fiscal 2022,” he said. “Combined with negative 1-per-cent revenue growth, the negative 7-per-cent operating leverage figure makes it unlikely that BNS will achieve a positive outcome this year. However, we do expect to see improvement, especially with management communicating tighter expense management in coming quarters. Historically BNS has been capable in this regard.”
“An 11.5-per-cent CET 1 ratio was slightly above our expectation. The bank is committed to a 12-per-cent CET 1 ratio by year end. A 20-30 basis points boost from Basel III reforms during Q2/23 will obviously help. Additionally, the bank chose to implement a 2-per-cent discount on its DRIP program, which should add another 5-10/ bps per quarter of CET 1 accretion.”
Lowering his projections to reflect lower NIM and higher expenses, Mr. Dechaine cut his target for Scotia shares to $72 from $75, reiterating a “sector perform” rating. The average target is $75.69.
Elsewhere, calling the EPS miss “significant” and seeing “less visibility near term,” Canaccord Genuity analyst Scott Chan downgraded the bank to “hold” from “buy” and cut his target to $74 from $82.
“We made net negative changes to our forecasts with our fiscal 23/24 EPS reducing by 7 per cent/4 per cent, respectively, mainly reflecting lower NII and slightly higher PCLs,” said Mr. Chan. “On NII, we expect to see continued margin pressure near term relative to peers (i.e., impacted by higher wholesale funding mix) while loan growth momentum should act as an offset. Further, we believe there could be large potential strategic changes in certain segments under the new leadership (e.g., in the International segment; see below), the details of which management might unveil during its Investor Day later in the year, thereby creating some near-term uncertainty on the strategic front.”
Others making changes include”
* Credit Suisse’s Joo Ho Kim to $72 from $76 with a “neutral” rating.
“Scotiabank’s Q1 results were weak, as both the bottom line and underlying results came in well below our forecasts,” said Mr. Kim. “Net interest margins were weak at the segment (especially at IB) and all-bank levels, while expenses also surprised to the downside. The bank maintained its guidance for the PCLs ratio this year (mid-30s), and we expect BNS to build towards the 12-per-cent CET1 ratio range by the end of the year. Beyond the quarterly results, while we certainly weren’t expecting to find signs of strategic direction from these results (especially given the recent CEO transition), we nevertheless believe guideposts on the way forward will be a key focus for the bank. Overall, we continue to believe a better upside elsewhere exists in the sector despite the pullback in the shares and the steep discount they trade at, which in our view reflects the uncertainties tied to the outlook.”
* RBC’s Darko Mihelic to $77 from $86 with a “sector perform” rating.
“Q1/23 results were below our expectations as lower results in Corporate (interest rate related) overshadowed better earnings from International Banking,” said Mr. Mihelic. “BNS exceeded our expectations on the performing PCL build. Despite an expected 20-30 bps benefit to capital in Q2/23 from the Basel III reforms, the bank instituted a discounted DRIP to further build capital. We are forced to adopt more conservative earnings estimates as we wait for more information on BNS’s longer-term plans, but we applaud what might be the beginning of a fortification of the balance sheet.”
* Desjardins Securities’ Doug Young to $76 from $78 with a “hold” rating.
“Adjusted pre-tax, pre-provision (PTPP) earnings were 11 per cent below our forecast, with the drag mostly related to the ‘other’ division, or more specifically, the bank’s interest rate positioning (to benefit from lower rates). This unfortunately adds confusion and overshadows what were decent international banking results,” said Mr. Young.
* Barclays’ John Aiken to $78 from $84 with an “equal-weight” rating.
“Higher expenses, continued funding cost increases and increasing losses out of its corporate segment weighed on results against expectations. While Scotia pursues its strategic review, the market’s patience may be tested as operating headwinds are likely to persist,” said Mr. Aiken.
* CIBC’s Paul Holden to $77 from $80 with a “neutral” rating.
“The near-term outlook justifies caution, while visibility over the medium term is challenged as we wait for an updated strategic plan,” said Mr. Holden.
* BMO’s Sohrab Movahedi to $75 from $85 with a “market perform” rating.
* TD Securities’ Mario Mendonca to $69 from $72 with a “hold” rating.