The major Canadian banks continue to offer very high dividend yields. In a previous article, I profiled the highest yielding bank in Canada, Canadian Imperial Bank of Commerce (CM). In this article, I will look at Royal Bank of Canada RY, which has a yield of more than 5%.
Company background and recent earnings
Royal Bank of Canada, or RBC, is the largest bank in Canada by assets and market capitalization. The bank has five reportable segments: Personal & Commercial Banking, Capital Markets, Wealth Management, Insurance and Investor & Treasury Services. RBC is diversified by business and geography.
Source: Royal Bank of Canada Q1 Presentation, slide 5.
Personal & Commercial Banking contributed slightly less than half of earnings in fiscal 2019, with Capital Markets and Wealth Management adding at least 20%. Insurance and Investor & Treasury Services added less than 10% combined to earnings.
The bank has 16 million clients, primarily in Canada and the U.S., but it also has a presence in more than 30 countries around the world.
RBC reported first quarter earnings results for full-year fiscal 2020 on Feb. 21. The bank earned $1.85 for the first quarter, which ended Jan 30, 2019. This was $0.11 ahead of estimates and 11% above results for the prior-year quarter. Revenue improved 10.2% to $9.7 billion, more than $1 billion higher than expected.
Personal & Commercial Banking grew net income 7.3% year-over-year. Loan volumes increased 6.5% while deposits were higher by almost 9%. Provisions for credit losses improved 8 basis points to 0.26% due to lower provisions on impaired loans in Personal & Commercial Banking and Wealth Management, showing that the bank’s loan portfolio is well managed.
RBC has the highest market share in Canada in a number of areas, including personal lending, credit cards, business loans and business deposits. Market leadership is especially important to RBC because 18% of clients have multiple types of accounts with the bank, compared to the peer average of 12%.
Net income for the Wealth Management segment grew 4.4%. Assets under management at the end of the quarter came in at 486.4 billion Canadian dollars ($343.93). With 53% of asset mix belonging to individuals, RBC is the largest retail fund company in Canada. Among banks in Canada, RBC has approximately a third of retail investor market share.
With market leadership comes pricing power. RBC received $113 million in fees during the quarter, nearly twice that of its peers in the Canadian banking sector. The bank also has a growing presence in the U.S. and is now the sixth largest wealth advisory firm in the country based on assets under management.
Capital Markets grew net income by 35% in the quarter, a record for this segment. Aiding results were low interest rates, making for a positive environment for equity trading as well as debt financing. The bank also saw a number of landmark transactions close during the quarter. RBC Capital Markets is now the ninth largest global investment bank by fees.
Insurance net income increased 9% due to new longevity reinsurance contracts. Premium and deposits were higher by more than 17%. This segment has maintained costs over the last two years even as revenue has grown. RBC now controls 39% of the market in individual disability sales in Canada, giving it the top position in this area in Canada.
Investor & Treasury Services net income declined 11.2% for the quarter. This was attributed to lower client deposit revenue on account of lower interest rates. Reduced client activity also negatively impacted asset services.
Overall, RBC had a strong first quarter, with both the top and bottom lines growing double-digits. Capital markets had a record quarter, and the rest of the bank’s businesses were mostly higher than the previous year. The lone exception was Investor & Treasury Services, but issues here, like interest rates, are largely outside of RBC’s control. This segment is also the smallest within the company.
Dividend and valuation analysis
Aside from its business, RBC’s dividend and valuation have caught my eye.
RBC has raised its dividend for nine consecutive years in Canadian dollars. U.S. investors have seen a 4.7% annual dividend raise over the past decade. This includes two years (2015 and 2016) where these investors saw a decrease due to currency exchange. RBC wasn’t forced to cut its dividend in the last recession, but did pause growth in 2009 and 2010 before authorizing an increase in 2011.
The bank raised its dividend by 2.9% for the upcoming May 22 payment, and shares currently yield 5.5%. For comparison purposes, today’s yield is significantly above RBC’s 10-year average yield of 3.9%. The current yield is also 2.5 times that of the average yield of the S&P 500.
I believe the dividend is safe, as the expected earnings payout ratio is just over 53% for 2020. This is slightly above the 10-year average payout ratio of 48%, but still very much on the safe side, and I don’t believe the dividend is in danger of being cut even with a sizeable decrease in earnings.
Aside from a strong business performance and high but safe yield, RBC is also trading with a low valuation.
Shares of RBC closed the April 21 trading session at $59.12. Last year, the bank earned $6.72 per share for a trailing price-earnings ratio of 8.8. Using the average analyst estimate of $6.18 for the current fiscal year, the stock trades with a forward price-earnings ratio of 9.6. The stock had an average valuation of 12.4 times EPS from 2010 to 2019.
RBC’s leadership position in multiple areas of banking and finance have helped make it the largest bank in Canada. For this reason, I feel that shares are undervalued at the moment. I believe a price-earnings ratio range of 10 to 12 seems appropriate given its leadership in Canadian banking. Reaching this range would result in a 4.5% to 25.4% increase in share price. Throw in the dividend and you have the makings of at least a high single-digit return.
Final thoughts
Investors looking for higher yields from the banking sector should look to Canada, as each of the large institutions there has at least a 5% dividend yield. While RBC does have the lowest yield among its peers, the bank might be my favorite in the space. With a price-earnings ratio below 10, I think RBC shares could see an excellent total return if the valuation were to rise to the low double-digits.
Disclosure: The author is not long any stock mentioned in this article.
Read more here:
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