The large Canadian financial institutions have begun to report quarterly earnings results. First out of the gate is the Bank of Nova Scotia (BNS, Financial), otherwise known as Scotiabank, with somewhat mixed results.
The company also raised its dividend by a double-digit percentage, continuing Scotiabank’s trend of raising its payout every year since the end of the last recession.
Scotiabank trades with a valuation at the very low end of the long-term range even as the company navigated the Covid-19 pandemic well and has posted solid to strong results over the past four quarters. This suggests that those buying the stock today could be well rewarded not only with a high dividend but with capital gains as well. Let’s dig deeper into Scotiabank's recent results to see why I think the stock is undervalued.
A rundown of earnings highlights
Scotiabank reported fourth-quarter and fiscal year 2021 results on Nov. 30 (the company’s fiscal year ends Oct. 31). All figures are in U.S. dollars unless noted.
For fiscal year 2021, revenue grew 6.1% to $25 billion while adjusted earnings per share surged 55% to $6.28.
Revenue for the quarter improved 3.7% to just over $6 billion, but fell $265 million short of what Wall Street analysts had anticipated. Adjusted earnings per share of $1.64 compared favorably to adjusted earnings per share of $1.12 in the prior year quarter and were 15 cents above estimates.
Using the average U.S. dollar to Canadian dollar exchange rate for the quarter, Scotiabank’s provision for credit losses (PCL) of $134 million compared favorably to $309 million in the third quarter of fiscal year 2021 and $854 million in the same period of the prior year. The PCL ratio was 0.10%, 63 basis points better than the prior year, and the PCL ratio on impaired loans was 0.31%, a 23 basis point improvement from the fourth quarter of 2020.
Canadian Banking was the best performer during the quarter as net income was up 59% from the prior year and 15% on a sequential basis. Revenue increased in the low double-digits, mostly due to a 22% improvement in non-interest income as a result of higher fee income. Net interest margin fell 6 basis points from last year. Net interest income was up high single-digits due to a robust loan environment. Total loans improved double-digits thanks to a 13% increase in residential mortgages and an 11% gain in business loans. Deposits were higher by 7%.
Global Wealth Management had double-digits gains in both net income and revenue in contrast to the fourth-quarter of 2020, but were essentially flat quarter-over-quarter. The Canadian wealth management segment posted its 11th consecutive quarter of double-digit adjusted net income growth. International also performed well, with a gain of 24% on a currency neutral basis. Increases in client assets, brokerage fees and private banking also boded well for Scotiabank. Expenses were up 14%, but this was due to a higher volume of activity. Assets under management and assets under administration both grew 19% from the prior year.
Global Banking and Markets net income improved 9% due to the release of provisions for credit losses and a return to normalized market conditions. Revenue was lower by 3% as higher net interest income was more than offset by weaker non-interest income. Loans fell 4% while deposits improved 7%.
Net income for the International Banking segment more than doubled, mostly due to release of provisions for credit losses. Revenue was down 1%, which was driven by lower revenue from capital markets.
According to analysts surveyed by Yahoo Finance, Scotiabank is expected to earn $6.52 in fiscal year 2022. This would be a 3.8% increase from last fiscal year if achieved.
Takeaways
Scotiabank, along with all of the other large financial institutions, grappled with high PCLs during the worst part of the economic crisis in 2020. This has largely abated as the economy has recovered. As a result, revenue and adjusted earnings per share are near or above pre-Covid numbers. PCLs represented less than 1% of Scotiabank’s total loan portfolio for the quarter, so the company’s loan book looks extremely strong.
Scotiabank does continue to see a benefit from lower provisions for credit losses, but this wasn’t the only factor in gains. Non-interest income and loan growth also drove the company’s improvement in the quarter. International also remains a bright spot.
Net interest income might be the weakest part of Scotiabank at the moment, but this revenue source was down just marginally from the prior year. One potential catalyst is that the Bank of Canada singled at the end of October that it could raise interest rates in early April of 2022. After previously eyeing the second-half of next year, Bank of Canada governors viewed economic growth and employment gains as better than expected. High vaccination rates were also cited as a reason for sooner than expected interest rate hikes.
The Canadian Banking segment, the largest source of income and revenue for Scotiabank, saw its net interest margin fall slightly in the fourth-quarter. The company stands to benefit from interest rate hikes, especially if they occur ahead of schedule.
In addition, it likely won’t be very long before the Federal Reserve follows suit and raises interest rates in the U.S. Other countries that Scotiabank has a presence in, such as Mexico and Chile, could also increase their interest rates. Add to this ongoing solid loan growth and Scotiabank’s net interest income could be much improved this time next year, reversing recent trends.
Valuation and dividend analysis
Scotiabank trades for close to $66. Using estimates for the fiscal year 2022, the stock has a forward price-earnings ratio of 10.1. According to Value Line, shares have averaged a little more than 11 times earnings since 2011.
The stock has traded in a very tight range of 10 to 12 times earnings over the last decade, which gives us an appropriate place to start when valuing Scotiabank. Applying earnings per share estimates to these long-term averages results in a price target of $65 to $78. On the low end, shares are just slightly overvalued, but could return 18% at the high end.
And that’s without the dividend. Scotiabank announced an 11% dividend increase (in Canadian dollars) at the time of the earnings release. U.S. investors will see a 77.99 cent dividend for the Jan. 27, 2022 payment date. This is 10.4% raise from the payment year-over-year.
U.S. investors should always take note of currency fluctuation, but the new annualized dividend of $3.12 equates to a yield of 4.7%. This is just ahead of the 10-year average yield of 4.4% for the stock, but nearly four times the average yield of the S&P 500 Index.
Final thoughts
Shares of Scotiabank have gained more than 30% over the last year. Even so, the valuation continues to remain near the low end of the stock’s own historical average. Given its history, it is likely that Scotiabank will continue to trade in a very tight range. The company also raised its dividend by a high rate recently. In the best-case scenario, my valuation model estimates that total returns could stretch into the low 20% range. This suggests an excellent risk/reward proposition.
