CA - National Bank Of Canada: Encouraging Financial Market Growth But Outlook Remains Uncertain

2023-12-11 15:13:46 ET

Summary

• National Bank of Canada has seen encouraging growth across non-interest income for the Financial Markets segment.
• However, net income growth itself has remained modest.
• I rate National Bank of Canada as a hold at this time.

Investment Thesis: I continue to rate National Bank of Canada as a hold at this time.

In a previous article back in September, I made the argument that National Bank of Canada ( NA:CA ) could see modest performance going forward, unless we see a significant rebound in growth for both net interest income and equity market performance.

Since then, the stock has ascended to a price of CAD $94.55 at the time of writing, back from a low of just under $85:

The purpose of this article is to assess whether National Bank of Canada has the ability to see continued growth from here, taking recent performance into consideration.

Performance

When looking at the most recent earnings results for National Bank of Canada, we can see that adjusted net income was up by 17% from the prior year quarter - with diluted earnings per share also up by 17% over the period.

When looking at the trajectory of net income (both net and non-interest income less expenses), we can see that the same came in lower in Q3 and Q4 as compared to the same period last year.

With that being said, net interest income across the Personal and Commercial segment saw growth from CAD 785 million in Q4 2022 to CAD 857 million in Q4 2023. Instead, the big drop in overall net interest income to CAD 735 million from that of CAD 1.207 billion from the prior year quarter was down to a drop of CAD 527 million across the Financial Markets segment. This was also an issue in the previous quarter, with a drop of CAD 397 million as compared to the prior year quarter - but losses have since deepened.

My Perspective and Looking Forward

As regards my take on the above results and the implications for the growth trajectory of the stock going forward, I had previously made the argument that in spite of continued growth across the Personal and Commercial segment - lack of a recovery across the Financial Markets segment would mean that overall growth in net interest income remains limited.

When looking at Q4 performance over the past five years, we see that net interest income across Financial Markets is down sharply as compared to prior years.

Conversely, we can see that non-interest income is up substantially across the Financial Markets segment. However, the drop in net interest income has also led to modest growth in net income of 4% from the prior year quarter - which, all being equal, would have been higher had we seen stronger performance of net interest income across the Financial Markets segment.

While performance across capital markets has been strong, which has led to an increase in non-interest income - net interest income across the Financial Markets segment has been affected up until now by declining M&A activity.

With interest rate raises having increased the cost of borrowing, this coupled with economic uncertainty has discouraged deal-making in the current climate and this is one of the reasons why we have seen a significant dip in net interest income across Financial Markets. We saw that earlier this year, M&A activity across the U.S. and Canada had dropped by 39% in Q2 as compared to that of the prior year quarter.

Going forward, I take the view that M&A activity has the capacity to rebound as interest rates start to stabilize - with the Bank of Canada having held its key overnight rate at 5% earlier this month, and speculation that a rate cut could be on the way in March with signs that higher rates are now starting to restrain spending.

Should this be the case, then I take the view that we could stand to see a significant rebound in net interest income across the Financial Markets segment, with non-interest income also set to see continued strength provided that market performance remains strong.

We can see that National Bank of Canada's price to book ratio has descended significantly over the past three years, but return on equity is also at a five-year low:

Price to Book ratio

Return on Equity

In this regard, I take the view that National Bank of Canada is potentially trading at good value given the low price to book ratio. However, I am also of the opinion that the stock will need to see a rebound in return on equity as well as an acceleration in overall net income growth to see substantial upside in the stock.

Risks

In terms of the potential risks to National Bank of Canada at this time, the stock's trajectory is likely to be tied to evolving macroeconomic conditions from here.

For instance, the state of the broader economy is still uncertain - and it is unknown as to whether the full effects of higher rates will be felt in 2024 by way of slower global growth. The OECD is forecasting that growth will slow from 2.9% this year to 2.7% in 2024, as consumer price inflation continues to decline given higher rates.

However, I take the view that the main risk in this regard could be the impact on the Financial Markets segment more generally. While growth in equity markets has allowed for a significant rise in non-interest income across the segment - this could see a reversal if we see equity markets decline in the coming year in the face of economic weakness. Should this be the case, then this could place pressure on overall net income growth.

Conclusion

To conclude, National Bank of Canada has seen encouraging growth in the Financial Markets segment in spite of pressure on net interest income. However, the economic outlook for the coming year continues to remain uncertain. In this regard, I continue to rate National Bank of Canada as a hold at this time.

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