The impact of market “uncertainties” are likely to be very evident during the coming third-quarter earnings season for Canadian banks, according to Desjardins Securities analyst Doug Young.
In a research note released Tuesday titled Come on shake your body baby do the conga, he said bank stocks “admittedly are not a late-cycle sector.” However, he now sees a mild recession baked into valuations for the sector.
“There’s a new ride at Disney World called Guardians of the Galaxy: Cosmic Rewind which pulls you backwards and spins you around while hurtling you up and down, all to a Gloria Estefan track —that’s what this last quarter felt like,” Mr. Young said.
“During 3Q FY22, the TSX fell 5.1 per cent and Canadian bank stocks were down 6.1per cent, with lots of volatility. This should be an OK quarter for the group. But given the macro backdrop, the ride might not yet be over.”
Ahead of earnings season, which kicks off with Bank of Nova Scotia on Aug. 23, Mr. Young is projecting a 5-per-cent decline in cash earnings per share year-over-year, “mostly as a result of swings in performing loan PCLs, which are tough to predict.”
The analyst said his focus remains on pre-tax, pre-provision earnings, which he expects to rise 3 per cent due to “strong” results in both Canadian and U.S. as well as international P&C banking.
“We may sound like a broken record, but inflation remains a big risk to our economy, a focus for investors, and the banks are not immune,” he said. “We are forecasting a 41 basis points year-over-year increase on average in the group’s adjusted efficiency ratio, and negative operating leverage on average in 3Q FY22.”
“We are not anticipating any big credit surprises. Rather, we expect impaired PCLs to normalize and the banks to build performing loan PCLs as a result of adjustments to forward-looking indicators and higher weightings toward pessimistic scenarios in light of current macro uncertainties.”
Citing the impact of market turbulence, Mr. Young reduced his target prices for bank stocks. In order of preference, his changes are:
- Toronto-Dominion Bank (
, “buy”) to $104 from $107. The average on the Street is $100.74. - Bank of Nova Scotia (
, “buy”) to $92 from $94. Average: $89.75. - Bank of Montreal (
, “buy”) to $153 from $155. Average: $153.15. - Canadian Western Bank (
, “buy”) to $36 from $38. Average: $36.75. - Royal Bank of Canada (
, “buy”) to $143 from $147. Average: $141.36. - National Bank of Canada (
, “hold”) to $100 from $103. Average: $103.25. - Canadian Imperial Bank of Commerce (CM-T, “hold”) to $74 from $77. Average: $78.43.
- Laurentian Bank of Canada (LB-T, “hold”) to $44 from $47. Average: $46.15.
“The Big 6 Canadian banks are all trading below their 20-year historical average P/4QF EPS multiples, and on average almost 20 per cent below historical average P/BVPS [price to book-value per share] multiples,” he said. “Over the near term, concerns around inflation, recession and the impact from the war in Ukraine could weigh on bank valuation multiples. We believe many of these concerns are already baked into current market prices. And if the Canadian economy remains resilient and recession concern eases, we could see valuation multiples improve; however, it is too early to make that call.”