2023-11-28 07:59:00 ET
Summary
- Royal Bank of Canada is expected to report a 3% increase in revenues for the fiscal fourth quarter.
- Analysts predict a 7% decline in earnings per share for the same period.
- Investors should pay attention to the net interest margin and credit losses as indicators of future performance.
Article Thesis
Royal Bank of Canada ( RY ) will report its quarterly earnings results on Thursday. In this article, we will take a look at what investors can expect from the bank for the period and we will evaluate whether Royal Bank of Canada is an attractive investment at current prices.
What Analysts Are Expecting From Royal Bank of Canada's Q4
Let's first take a look at what analysts are currently predicting when it comes to Royal Bank of Canada's fiscal fourth quarter earnings results.
Revenues
The consensus revenue estimate stands at $9.65 billion. This would represent an increase of a little more than 3% when compared to the previous year's period. This would be a reversal compared to the previous year's period when Royal Bank of Canada experienced a 3% revenue decline.
Compared to the last couple of quarters, a 3% revenue increase would represent a rather weak result as revenues had been up by 13% and 14% during the last two quarters, respectively.
Over the last five quarters, Royal Bank of Canada has beaten revenue estimates five times, with the average beat being around $500 million. If Royal Bank of Canada were to keep this track record intact, it could outperform expectations by about 5%, which would make for a revenue increase of around 8%.
Revenue estimates have trended downward over the last couple of months, with the Q4 revenue consensus being around 4% lower than it was three months ago, at the beginning of the quarter. Likewise, revenue estimates for the upcoming quarters have been trending down as well. This makes it easier for Royal Bank of Canada to outperform expectations, all else equal, although there is, of course, no guarantee that Royal Bank of Canada will report sales that are higher than what the analyst community is forecasting today.
Profits
The consensus earnings per share estimate for Royal Bank of Canada's fourth quarter currently stands at $1.92. This would represent a decline of around 7% compared to the previous year's quarter.
A profit decline in combination with higher revenues is a bit of a surprising combination, but margin headwinds from cost increases due to inflation and higher employee costs, in combination with higher credit costs, could explain this.
Royal Bank of Canada has beaten earnings per share estimates during three of the last five quarters. The average beat over that time frame was marginal, however. Analysts have thus, historically speaking, been more accurate when it comes to predicting Royal Bank of Canada's profits compared to the forecasts for Royal Bank of Canada's sales, where analysts have a clear track record of underestimating the company.
Earnings per share estimates have trended down over the last couple of months as well. Over the last three months, the consensus earnings per share estimate has dropped by 8%, while earnings per share estimates declined by 1% over the last month. This, again, makes sense from the perspective of analysts - when they lower their revenue estimates, they should adjust their profit estimates as well, all else equal.
What Investors Should Look Out For
While the absolute headline performance (sales and profits) of Royal Bank of Canada will be important when the company reports its results on Thursday, there are also other items investors should keep an eye on.
One of these is the net interest margin. While net interest margin changes are partially reflected in the company's revenues, they also can give us some clues about the revenue performance in upcoming quarters. If the net interest margin went up during the fourth quarter, there's a good chance that this trend will have a positive impact during the next quarter, or possibly the next couple of quarters, as well. If, however, the net interest margin declined during the period, then the net interest margin momentum could work against Royal Bank of Canada during the upcoming quarters, too.
The macro environment has not been great in the recent past due to several headwinds, including inflation, the war in Ukraine, the conflict in the Middle East, and so on. This has made investors worry more about potential credit risks when it comes to major banks, including Royal Bank of Canada. Investors should thus be looking for clues when it comes to credit losses during the coming quarters. The company's charge-off rate during the most recent quarter is one such clue - an increase could mean that future credit losses could climb, while a stable or even declining charge-off rate should be seen as a positive sign.
In general, Canadian banks have pretty low credit risks as they fared a lot better than their US peers during the housing crash. The charge-off rates of major Canadian banks are also, on average, a lot lower compared to the charge-off rates we see at major US-based banks. Royal Bank of Canada's provisions for credit losses during the third quarter, for example, stood at just C$620 million, or just 29 base points - JPMorgan ( JPM ), the largest US-based bank, had provisions for credit losses of US$1.4 billion, or around 1% of the average loans of US$1.3 trillion.
So while credit losses have not been a problem at Royal Bank of Canada in the past, changes in the bank's credit losses could still be telling when it comes to the future.
Investors also should take a look at Royal Bank of Canada's common equity tier 1, or CET1, ratio. This metric does not only give us clues about the risks of an investment in Royal Bank of Canada, but the metric can also tell us about the bank's potential when it comes to shareholder returns in the future. An increase in the ratio makes a dividend increase and/or higher share buybacks more likely, as an increase in the CET1 ratio suggests a rising amount of surplus capital that could be utilized for more generous shareholder payouts.
Is Royal Bank of Canada A Good Investment?
While the strength of the company's upcoming quarterly results will give us some clues about whether the bank's shares are a good investment, we should take a look at other things, such as the bank's valuation.
Based on current estimates, Royal Bank of Canada trades for 10.6x this year's earnings (actually last year's earnings, as the new fiscal year has already begun in October). This makes for an earnings yield of more than 9%, which is pretty attractive. Looking at the earnings estimate for the fiscal year that has just started, we see an earnings multiple of 10.3, which naturally is even more attractive.
It's worth noting that while this valuation is pretty attractive in absolute terms, even lower earnings multiples can be seen at some other major banks: JPMorgan trades at just above 9x this year's expected net profits, for example. Of course, one can argue that the stronger credit portfolio and lower charge-offs and provisions at Royal Bank of Canada justify a bit of a premium, but for bargain hunters looking for the cheapest bank, Royal Bank of Canada is not the best pick, despite the fact that it's far from expensive in absolute terms.
When we look at Royal Bank of Canada's current valuation vs. the historic valuation for the bank, we see the following:
Today, Royal Bank of Canada trades for 1.8x tangible book value. This represents a pretty large discount of a little more than 20% when compared to the median tangible book value multiple over the last five years. There is, of course, no guarantee that Royal Bank of Canada's valuation will expand to the longer-term median, but we can say that Royal Bank of Canada is trading at a rather low valuation today, compared to how the company used to be valued. This suggests that right now is a better-than-average time to enter or expand a position.
The bank's dividend yield stands at 4.6% today, which is pretty attractive, both compared to what is available from many other stocks, and also compared to what the bank's dividend yield was in the past.
Takeaway
All in all, Royal Bank of Canada is not an absolute bargain, but an inexpensively-valued quality bank with below-average credit risks, some valuation upside, and some nice income generation potential on top of that. If Royal Bank of Canada outperforms expectations with its upcoming quarterly earnings, that makes it an even better choice - and history suggests that the likelihood of an earnings beat is far from small.
For further details see:
What To Expect From Royal Bank of Canada's Q4 Earnings Results?