NTIOF - National Bank of Canada: Strong Dividend Growth And Higher Earnings Ahead

2023-07-07 15:27:05 ET

Summary

• National Bank of Canada has outperformed other Big Six Canadian banks over the last 12 months and the past decade, providing 92.9% more returns than the runner-up, Royal Bank of Canada.
• The bank's smaller size, dominant position in Quebec, and diversified business across personal and commercial banking, financial markets, and wealth management have contributed to its resilience.
• Despite potential recession risks, National Bank offers a safe dividend yield of almost 4.2% and is expected to deliver reasonable total returns of around 8% per year over the next few years.
• We rate it as a "Hold" as there are quality bank stocks offering better value today.
• That said, we believe it will come time such as during an economic expansion when National Bank will likely outperform in higher earnings and dividend growth.

National Bank of Canada ( NTIOF )( NA:CA ) has been the most resilient in this banking selloff that saw a decline in most of the other Big Six Canadian bank stocks over the last 12 months.

Shown below, National Bank's 10-year price action is even more impressive, as once again, it is the best performer. It maintains first place when dividends are included in the total return calculation. The accumulation of this outperformance over a decade led to 92.9% more returns compared to runner-up Royal Bank of Canada ( RY )( RY:CA ).

In other words, if you invested $10,000 in National Bank 10 years ago, you would have about $40,160 (including dividends received) or $9,290 more than if you had made the same investment in Royal Bank.

(The company reports in Canadian dollars, so the figures in this article are in C$ unless otherwise noted.)

National Bank's Advantage

National Bank may have some advantage as the smallest player of the Big Six Canadian Banks. Its enterprise value and market cap are about $60 billion and $33.2 billion, which are about 14% and 19%, respectively, of Royal Bank's size.

National Bank's fiscal 2022 revenue and net income were $9.6 billion and $3.4 billion, respectively. Again, this is a fraction of Royal Bank's revenue and net income of almost $48.8 billion and $15.8 billion, respectively, for the last fiscal year. Naturally, from a number perspective, it would be easier to grow a smaller business than a bigger business.

Additionally, National Bank has a dominant position in the province of Quebec, which might allow it to have better operational efficiency being focused on that geographic area.

The bank has a diversified business across primarily personal and commercial banking, financial markets, and wealth management. Additionally, its U.S. specialty finance and international segment complements these Canadian operations.

Recent Results

National Bank of Canada reported its fiscal Q2 2023 results on May 31. In the first half of the fiscal year, revenue climbed 3% to $5,061 million -- net interest income declined 25% to $1,981 million but non-interest income jumped 36% to $3,080 million.

Non-interest expense rose 8% to $2,777 million. As well, provisions for credit losses jumped to $171 million from $1 million in the same prior-year period, as bad loans are expected to rise in a potential recessionary environment.

Consequently, net income fell 5% to $1,728 million or fell 6% on a per-share basis. Adjusted net income dropped 4% to $1,752 million. Adjusted earnings per share ("EPS") also dropped 4% to $4.94, leading to a payout ratio of about 40% for GAAP and adjusted EPS.

Dividend

Indeed, National Bank's payout ratio is the lowest among the Big Six Canadian banks, which typically normally range 40-50%. This may be why of the five banks, including National Bank ( Toronto-Dominion Bank ( TD )( TD:CA ) is the exclusion), of the Big Six Canadian banks that raised their common stock dividend this year, National Bank had the largest hike of 5.2%, which was a double versus the average increase of 2.6% of the other four banks. This increase was compared to the prior quarter's dividend.

The year-over-year increase was 10.9% (versus the average increase of 4.8% of the other four banks). The trailing-12-month increase was 15.1% (versus the average increase of 8.9%).

National Bank's recent bigger dividend hike was not a one-off. The bank's 3-, 5-, 10-, and 15-year dividend growth rates have led its peers as compared to the average of the other big four banks.

The bank's above-average long-term earnings growth helped drive its top-notch dividend growth in these periods. Specifically, in the past 10 fiscal years, the bank increased its adjusted EPS by close to 9.4% per year.

National Bank's dividend-paying history is stellar. It has paid dividends non-stop for about 133 years. And it has maintained or increased its dividend since at least fiscal 2003.

The bank froze its dividend in fiscal 2009 and 2010 around the global financial crisis -- a restriction by the regulator, the Office of the Superintendent of Financial Institutions, to ensure the Canadian financial system stayed intact during difficult economic times. The bank also froze its dividend in fiscal 2021, likely related to the pandemic impacts.

The bank maintains profitability and is able to increase its earnings over time through economic cycles. It last reported retained earnings of $15,943 million, which could act as a strong buffer for its dividend.

Outlook and Valuation

The bank's near- to medium-term earnings could be stalled to a growth rate of about 3% due to a potential recession and higher provisions for credit losses. In this BNN Bloomberg article last month, it noted economists expecting a recession in Canada in 2023 or 2024.

The bank stock's price-to-earnings chart shown above suggests a near-term target of about $106, which is based on a very moderate earnings-per-share growth of about 1% in fiscal 2023 and 3% in fiscal 2024 and a target price-to-earnings ratio of 10.6. This suggests the stock is fairly valued at $97.58 at writing.

Wall St. analysts agree the stock is fairly valued. They believe the stock trades at a discount of about 6% from the average price target of $104.15 per share, which also suggests a near-term upside potential of 7%.

Investor Takeaway

National Bank of Canada offers a dividend yield of almost 4.2%, which is safe dividend income. With the looming clouds of a recession, its growth will be slowed, and the stock will remain depressed. Based on its fair valuation, it could still deliver reasonable total returns of more or less 8% per year over the next few years.

The economic cycle goes through the different phases, and eventually, it will come time for an economic expansion, during which National Bank will likely outperform in higher earnings and dividend growth. Now is not that time yet. Given that there are better-valued, quality bank stocks available, we rate National Bank as a "Hold".

Risks come with every investment. For the bank, other than a looming recession that's dampening its growth outlook, it also has concentration risk in Canada, particularly, Quebec. So far, this has been good for the bank and its long-term shareholders, as illustrated earlier in its past results in earnings and dividend growth. However, there may come a time that this concentration risk could play out.

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