Tuesday, March 17, 2015

Stock Analysis -- Royal Bank of Canada (NYSE:RY)



Royal Bank of Canada (RY) is Canada's largest bank as measured by both assets and market capitalization. The company is organized into five business segments: Personal & Commercial Banking, Capital Markets, Wealth Management, Insurance and Investor & Treasury.  Although RBU’s recent FQ1 net income beat analysts’ estimate and reported strong earnings, its market price performance isn’t so good, due to fears over increasingly difficult market, including low oil prices, weaken Canadian dollars, and Canadian housing bubble.


(Data from Google Finance)


I usually do my stock purchase decision based on my own Stock Purchase Criteria. For a bank analysis, I altered the criteria a little bit to tailor into banks’ characteristics.



Yahoo Finance includes RBC quarterly dividends from 1996 onwards.  RBU increased dividends almost every year in 19 years since 1996, only with the exception of 2009, in which year the dividends decreased slightly from $1.885 in 2008 to $1.729 in 2009.  RBU is one of David Fisher’s Dividend Challengers with 5 consecutive years of higher dividends. 


 
(Data from Yahoo Finance)


S&P Capital IQ rates this bank A-, and analysts give it a “LOW” risk rating with these comments:


Our risk assessment reflects our view of RY's strong business fundamentals, diverse product lines and large market share in the improving North American economy.

Morning Star gives it a favorable 3-star rating.

RBU’s current dividend yield is 4%, based on current market price USD60 and annual dividends USD2.42.  Payout ratio is at 46.60%, with a lot of space for dividend increase.

RBU’s annual average dividend growth rate (DGR) is $18.43% since 1996; the last 10-year average yearly DGR is 10.25%;  Its DGR has been slowed down since 2009, which is averaged at 5.58%.  Considering the high yield rate 4%, 5.58% DGR is still acceptable, which means it will take RBU around 15 years to achieve 10% annual return rate.  Chowder number is 12.05%, past the 12% threshold.

Below several indicators (except EPS growth) are bank specific in my own Stock Purchase Criteria.

RBU’s 10-year earnings per share (EPS) growth is healthy and uptrend, well above annual dividends.

 (Data from MorningStar)


Return On Equity (ROE) shows how well a bank turns its equity into earnings. In the long run, a 10% ROE is preferred.  RBC’s current ROE is 19.39%, which is very solid.  Actually, if we look at history, RBU’s ROE rates were all higher than 10% in each year during 2005 – 2014, including the recent economic recession. 




Net interest margin (NIM) measures how profitably a bank is making investments. It takes the interest a bank makes on its loans and securities, subtracts out the interest it pays on deposits and debt, and divides it all over the value of those loans and securities. For a traditional bank, it's notable if a bank's net interest margin is below 3% (not good) or above 4% (quite good).  RBC’s net interest margin is 1.86%, lower than 3% criterio.  It is understandable since RBU’s Q1’15 net interest income is about 37.6% of total revenue ($3,631 net interest income vs. $9,644 total revenue).  If we compare RY's net interest margins to those of its competitors TD and BNS, we'll see RY's NIM is lower than competitors.  Net interest margins continue to reflect competitive pressures and the low interest rate environment.
 

The efficiency ratio takes the non-interest expenses (salaries, building costs, technology, etc.) and divides them into revenue. So, the lower the better. A reading below 50% is the gold standard. A reading above 70% could be cause for concern.  RBU’s efficiency ratio is an outstanding 47.90%.

Tier 1 common capital ratio (CET1) is a measurement of a bank's core equity capital compared with its total risk-weighted assets. This is the measure of a bank's financial strength.  A firm must have a Tier 1 capital ratio of 6% or greater to be classified as Well-Capitalized. RBC has CET1 ratio at 9.6%, Tier 1 capital ratio at 11%, which means RBC is well-capitalized by practically any standard.

Overall, RBC is a strong solid bank to own in the long run.  In recent years, RY has delivered the strongest
and most reliable results of the Canadian banks, recording positive contributions from all business lines. S&P Capital IQ gives it 12-month target price at US$70, fair value at $67, and a "buy" recommendation, taking into consideration of the risks including a commercial real estate or condominium asset bubble in Canada, a U.S. economic slowdown and prolonged low interest rates.  RBC's current price is US$60, which is 11% off its fair value.

Disclosure:  Currently I have an April put written at $55, and will buy 100 shares if assigned.  I also have 30 shares on GTC limit order at $58.


4 comments:

  1. Like the lowball put offer. What kind of yield is that returning?

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    Replies
    1. Hi FV, the annualized return is around 4.3%. I wrote the put in the beginning of March. I wish I did it more recently.

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  2. Great analysis. Good luck with your put option. I only have TD and BNS shares. Maybe it's time I looked into buying RY as well to diversify my financial holdings. The stock certainly doesn't look expensive by historical measures.

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