With its fiscal Q3 earnings due out next week on Aug. 29th, today I’ll be covering the latest in my series on Canadian-based banks, and this time we turn our attention to The Bank of Nova Scotia (NYSE:BNS), also known more commonly as Scotiabank.
For readers less familiar with this firm, here are a few tidbits from their corporate profile: trades on both the Toronto exchange and NYSE, $1.3T in assets, business segments span across personal / commercial banking as well as investment banking & capital markets.
To get a “holistic” rating score of buy, sell, or hold, I break down my analysis into 5 categories: dividends, share price, valuation, earnings growth, & capital strength.
If I recommend the stock on at least 3 of these categories it gets a hold rating, and at least 4 will give it a buy rating. A score of less than 3 is a sell rating.
This stock is my latest dividend quick pick for the month, coming in at near 7% dividend yield, currently 6.71% according to official data on Aug. 23rd.
The payout of $0.80 per share quarterly has proven to be steady, and increasing lately. My dividend quick picks aim to find hidden dividend gems especially among market sectors like financials.
Important to point out is that this stock’s dividend yield is almost 82% higher than the sector average, which hovers closer to 3.8%, thus earning this stock an “A” grade from Seeking Alpha.
Also, since 2020 the dividend has been on a steady rise, as shown by the chart below, despite the dip in 2019:
For example, it went from $0.63 per share in 2020 to $0.80 per share in 2023, a 27% increase.
Therefore, I would highly recommend Scotiabank in the category of dividends, based on the evidence I presented.
In the following section, I will demonstrate how the dividend income from this stock could potentially benefit a dividend-oriented investing idea.
Share Price: Recommended
To decide if the current share price should be recommended as a buy opportunity, I want to determine if it fits my target goal for return on capital but also my risk tolerance for capital loss.
First, I pull the current YChart and I’m tracking the pre-market share price on Aug. 23rd of $45.44, comparing it to its 200-day simple moving average of $50.07, which it is significantly below.
Next, I determine that I want to buy 10 shares at the current price and hold for 1 year to earn the full dividend income, then sell the shares. I create two trading scenarios below.
In the first simulation, I assume the current 200-day SMA will go up by 10% in a year, and that will be my sell price. My goal is a positive +10% return on capital invested. As the simulation shows, I would exceed that goal and achieve +28.25% total return. The tax events that could potentially occur are dividend income and capital gains.
In the 2nd simulation, I am testing my risk tolerance of maximum -10% negative return on capital. I assume the current 200-day SMA will drop by 10% in a year and I will have to sell at that price. However, this scenario projects a +6.21% return on capital, since my small capital loss is offset by dividend income, as the table shows.
Since the two trading scenarios both exceed my profit goal and also fall within my loss limit, the current buy price of $45.44 can be recommended as a buying opportunity right now.
This profit/loss scenario may not fit your own portfolio goals, so please only refer to this as a simplified framework to think about this stock as a long-term investor might, and anticipation of both capital gains and losses since both can occur.
Incidentally, look at what happens to my total return if I buy at $54 and not $45. It would lead to a negative return of -10.62%, which exceeds my loss tolerance of -10% return. Hence, a buy price of $54 would not be recommended.
The question I often ask is: does this stock present a reasonable valuation compared to its sector?
To determine that, I used official valuation data as of Aug. 23rd and the two key metrics to look at are forward price-to-earnings and forward price-to-book values.
At this time, the P/E ratio is an attractive 9.28, being over 6% below the sector average which is hovering close to 10x earnings.
The P/B of 1.03 is slightly higher than the sector average of 1.01x earnings, but nothing too ridiculous.
By comparison, TD has a forward price-to-earnings that is 22% higher than the sector average, and a forward price-to-book 38% higher than the average. Bank of Montreal‘s forward P/E is 44% above the average, with a forward P/B 10% above the average.
Hence, I would gladly recommend Scotiabank as having an attractive valuation compared to its peer sector, so definitely worth considering at these valuations.
Earnings Growth: Not Recommended
The first thing that grabbed my attention is weak YoY net income growth when looking at the most recent quarterly results.
What is interesting, considering the current rate environment that has benefited many banks, when it comes to this one they saw top-line interest YoY growth however their net interest income “NII” took a hit, likely from higher interest expenses YoY, as I have highlighted in the table below. In particular, their interest expense on deposits shot up significantly YoY.
To make sense of what was driving down their bottom line in the last quarter, I turned to their commentary. A running theme was earnings “impacted by normalization in provision for credit losses” in both the Canadian banking segment and the international banking segment.
Also according to their commentary on the global wealth management segment, “challenging market conditions continue to impact fee income.”
In addition, the diluted earnings per share also saw a YoY drop, based on the following table, which also showed a lower net interest margin and higher expenses YoY:
Based on the data, I don’t recommend this stock in the category of earnings growth.
Capital Strength: Recommended
A key metric to look at when it comes to this bank’s capital strength is the CET1 ratio, which is a solid 12.3% at Scotiabank. This level is well beyond the regulatory minimums.
The company’s last quarterly earnings commentary also shed some positive light on their financial position:
The Bank reported a strengthened Common Equity Tier 1 (“CET1”) capital ratio of 12.3% and announced a quarterly dividend increase of 3 cents to $1.06 per share. The Bank also made progress in building its liquidity position with double digit year-over-year customer deposit growth, which outpaced loan growth in the quarter. The Liquidity Coverage Ratio (“LCR”) was a healthy 131% at quarter end, up from 122% in the prior period.
In this category I would also say something more about deposit growth, which has been on a positive uptrend for this bank for several years. This is a sign of continuing inflows of new money into this bank, which I consider a sign of client confidence in the brand, despite the rocky banking environment this past spring.
I would certainly recommend this bank on capital strength, but also want to mention why it is a rating category. I think it’s important to evaluate a company’s potential to remain solvent for the foreseeable future, before making investing decisions, so while you cannot predict with certainty every possible scenario with a bank.. you can reduce risk by gauging the capital health of a firm in comparison with its sector and comparing to key peers.
Some of these large Canada-based banks I have covered are showing just that.. capital strength. For example, CIBC has a CET1 of 11.9% and a liquidity coverage ratio of 124%, according to my analysis of CIBC in July. This means Scotiabank is able to be highly competitive in this category with the likes of CIBC, a heavyweight in Canadian banking.
Rating Score: Buy
This stock won in 4 of my 5 rating categories today and earned a “buy” rating, which is more bullish than the consensus both from analysts and the quant system.
Risk to my Outlook: CRE Exposure
A risk to my buy rating outlook, that I think is worth considering, is investor & market concern over exposure to commercial real estate debt, which is still an ongoing issue in this sector.
And rightfully so, considering that even the Federal Reserve Bank of St. Louis released a July article highlighting the issue. Here is some of what they had to say:
Thus far, most of the concern about commercial real estate is focused on the office sector, which accounts for about 15% of the $21 trillion CRE market. The national vacancy rate in the office sector was 17%.
Much of the weakening in the office market can be attributed to an increase in remote work that began during the COVID-19 pandemic. The continuation of remote and hybrid work, even as the pandemic ebbs, has lowered the demand for office space, resulting in lower valuations, falling rents and rising vacancy rates.
Now, let’s talk about what that means for Scotiabank specifically.
I think it adequate to simply show the official CRE position of this company, which shows the office segment being just 7% of the CRE portfolio, and when also including Office REITs it amounts to no more than 10%.
I’m not sure that geographic diversification helps in this case, since the issue of remote work affecting office space seems to be more global in nature. Residential & industrial is over 3/4ths of the CRE book, so that is where their primary risk is, and not office spaces necessarily. This should calm fears some investors may have about this type of risk exposure, thereby making a strong case for my “buy” rating.
Let’s go over the key points from today:
This stock received a buy rating, more bullish than the consensus from analysts and the quant system.
Positives: dividends, share price, valuation, capital strength
Headwinds: earnings YoY growth.
The risk of CRE exposure to office properties has been determined to be low.
This article wraps up my series this month on Canada-based banks that also trade in the US, after covering several lately. They continue to grab my attention, particularly when it comes to dividend yield.
This firm meet or beat earnings estimates in two of the last 4 quarters, missing on two of them. My educated prediction for the next one would be something like a 50/50 chance they beat estimates by around $0.04, and a 50/50 chance they miss by that amount.