2023-03-21 23:48:37 ET
Summary
- Royal Bank of Canada stock has declined the least among the Big 5 Canadian Bank stocks.
- The stock appears to be fairly valued and offers a safe dividend yield of ~4.1%.
- Particularly, the bank stock should appeal to risk-averse or conservative investors.
- We rate it as a buy on dips during this banking crisis, particularly for conservative investors seeking quality and safety.
Royal Bank of Canada ( RY ) ( RY:CA ) or RBC stock is as blue chip as it gets when it comes to Canadian banks. Among the Big 5 Canadian bank stocks, it has declined the least amid the banking sector downturn.
What about its long-term total returns? In the last 5 and 10 years, it has delivered the highest total returns. The chart below shows that it turned an initial investment of US$10,000 into about US$23,100 in 10 years. Arguably, RBC stock came out on top partly because the stock has been more resilient in this downturn.
Why RBC stock has been defensive
Royal Bank of Canada stock has been more resilient and defensive than its peers for multiple reasons, including the following.
First, RBC is large. It recently closed at a market cap of about US$131.6 billion. The runner-up, Toronto-Dominion Bank's ( TD ) (TSX: TD:CA ) market cap was about US$104.8 billion, about 20% smaller.
For fiscal 2022, RBC reported revenue of just under CAD$49 billion, which led to net income of CAD$15.8 billion and diluted earnings per share ("EPS") of CAD$11.06, which was flat versus fiscal 2021.
At the end of fiscal Q1, RBC's total assets were CAD$1.9 trillion, up 10% year over year. As well, its deposits were CAD$1.2 trillion, up 5% versus fiscal Q1 2022.
Along with TD Bank, Royal Bank of Canada were among 30 banks (as of the end of 2022) that are identified as global systematically important banks (" G-SIBs ") based on 12 indicators. Below is an infographic that shows the 5 broad categories of the indicators.
OSFI
Credit Suisse ( CS ) were also one of these 30 international banks that are too big to fail, and now it's being absorbed by UBS ( UBS ), which is also a G-SIBs.
Second, Royal Bank of Canada is also diversified. Its focus is in North America, as its revenue mix is approximately 59% Canada, 25% the United States, and 16% international. As of the end of fiscal Q1 2023, it had 1,157 banking branches in Canada (down from 1,175 a year ago) , 69 in the U.S. (down from 73), and 39 in other geographies.
Moreover, it operates 5 business segments, as follows: Personal & Commercial Banking (roughly 40% of fiscal 2022 revenue), Wealth Management (30%), Capital Markets (18%), Insurance (7%), and Investor & Treasury Services (4%).
At the end of fiscal Q1, just under CAD$580 billion of its deposits were in its Personal & Commercial Banking business and CAD$185.6 billion were in its Wealth Management business.
Because of the diversity of its business, RBC has higher-quality earnings that have more certainty. For example, in 2020 during which the economy was hit hard by the coronavirus pandemic, RBC (i.e., NYSE:RY) stock saw its diluted EPS falling about 11% versus the Big 5 Canadian Bank's average EPS decline of about 14%.
RBC also targets a return on equity ("ROE") of over 16%. It had been on target with a 5-year ROE of 16.5%.
Dividend Safety
Royal Bank of Canada targets a payout ratio of 40-50%. Under normal market conditions, its payout ratio mostly lingers around 45%. During the pandemic year of 2020, its payout ratio propped up to about 55%.
At times of economic recessions, the regulator, Office of the Superintendent of Financial Institutions ("OSFI") would restrict the large Canadian financial institutions like RBC from raising their dividends or buying back their common stock to improve the stability of the financial system. This is why RBC stock froze its common stock dividend for 7 quarters during the pandemic. As soon as the restriction was lifted, the bank increased its dividend again.
RBC investors should be prepared for a potential dividend freeze that can come up as the banking crisis plays out . Investors may also be concerned that interest rates have risen too quickly, which could also lead to a recession.
Investors should note that RBC has not cut its common stock dividend since the late 1800s. Furthermore, its trailing-12-month payout ratio was 49%, and its retained earnings is over CAD$78.3 billion versus its annualized payout of about CAD$7.4 billion. Therefore, the bank has the buffer to protect its dividend.
RBC's returns potential
Royal Bank's medium-term objective targets diluted EPS growth of over 7%. In the past 10 years, RBC increased its adjusted EPS by 8.4% per year and dividend per share by 8.1% per year in Canadian dollars. However, when translated into U.S. dollars, they were compound annual growth rates ("CAGR") of 5% and 5.3%, respectively, only.
An investment in Royal Bank of Canada turned an initial CAD$10,000 into CAD$31,000 or annualized returns of almost 12%. As the second YCharts graph showed earlier, in U.S. dollars, the CAGR was 8.7%.
This is a reflection of foreign exchange risk that U.S. investors would be exposed to when they invest in RBC that primarily earns Canadian dollar revenues.
That said, risk and reward come hand in hand. Because the Federal Reserve has increased interest rates more aggressively than the Bank of Canada, U.S. dollars has strengthened against Canadian dollars in the last year. So, it could be a smart move for U.S. investors to use the greenback to invest in Canadian stocks.
Assuming a 7% EPS growth rate, and the stock reverts to its long-term normal multiple of about 12, the stock can deliver annualized returns of about 11.6% on the TSX over the next 5 years. U.S. investors can +/-2%, due to foreign exchange volatility, to approximate their returns potential over this period.
Valuation
As you can imagine, because RBC stock has fallen less than its peers, it also trades at a premium valuation to its peers. At CAD$129.78 (US$94.67) per share, it trades at about 11.4 times earnings, which is a 5% discount from its long-term normal price-to-earnings ratio ("P/E") of about 12. So, essentially, the bank stock is fairly valued.
Sure enough, analysts also generally think RBC stock is fairly valued. They believe the stock trades at a discount of 9% from the consensus 12-month price target of CAD$142.52 per share, which also implies near-term upside potential of 10%.
Yahoo Finance
Investor Takeaway
If Royal Bank of Canada's recent stock price action is telling, it is a relatively safe pick amid this banking crisis. It has declined the least among the Big 5 Canadian Bank stocks. So, it likely will not provide the highest returns over the next five years. However, its business diversity, quality earnings, and dividend safety would particularly appeal to risk averse or conservative investors who wish to buy shares in the banking sector.
Through solid single-digit EPS growth, its dividend yield of ~4.1%, and potentially a teeny weeny bit of valuation expansion, RBC stock can deliver annualized returns of ~11.6% over the next 5 years for TSX:RY investors. U.S. investors buying on the NYSE:RY could generate returns at a CAGR of ~9.6% to ~13.6% over this period due to changes in the forex.
Other References
For further details see:
Royal Bank of Canada: A Defensive Pick Amid This Banking Crisis