Toronto-based Equitable Group Inc. has shown why it can pay to look beyond the big banks: The stock has surged more than 20 per cent since the company reported its quarterly results on Friday, and many observers believe the stock is still worth a look.
Make no mistake, the Big Six banks are diversified, dividend-generating machines that should be warmly embraced by investors.
But the smaller financial players are demonstrating that they have some competitive advantages, now that the rise of online banking is calling into the question the need for expensive national branch networks.
Equitable Group, which controls Equitable Bank and is largely a mortgage lender, is a fraction of the size of Canada's Big Six, with a market capitalization of just $1.2-billion. But its fourth-quarter results, and the reaction from the market, suggest that its small size may be a virtue.
Profit rose 33 per cent over last year, to $41.7-million or $2.56 a share. That's well above the profit of nearly $2.20 a share that a consensus of analysts had been expecting.
Mortgage originations rose 25 per cent, driven largely by a similar increase in deposit growth. EQ Bank, the digital-banking platform launched at the start of 2016, attracted $1-billion in deposits in its first year with customers attracted to its generous interest rates.
In an environment of slow economic growth, low interest rates and a worrisome housing market, these gains stand out.
Investors appear to agree: After the results were released, the shares surged 18.6 per cent. They rose another 2.9 per cent on Tuesday, to a fresh record high of $74.09, when markets reopened following a three-day weekend.
Is there any value left?
Analysts believe there is, based on the fact that the shares still look inexpensive relative to profits and book value.
According to Bloomberg, the shares trade at just 8.6-times trailing profit and 7.8-times estimated profit. That compares to an average estimated price-to-earnings ratio of 12.7 for the Big Six, and a P/E ratio of more than 10 for a smaller bank such as Laurentian Bank of Canada.
Jaeme Gloyn, an analyst at National Bank Financial, noted that Equitable's discount relative to the Big Six has widened to 47 per cent, up from a two-year average of about 30 per cent.
Similarly, Equitable's price-to-book value is just 1.3, which is well below the Big Six average price-to-book ratio of nearly 2.
Admittedly, Equitable Bank is not often compared with larger banks, given that it lacks capital markets capabilities, full wealth-management services or even a credit card. Indeed, its business activity is essentially limited to accepting deposits from its bank customers, providing day-to-day banking services and underwriting residential and commercial mortgages.
This lack of diversification could hurt if the housing market turns. This may explain why more than 6 per cent of Equitable's outstanding shares have been sold short by investors who are betting that the share price will decline. The stock's short-interest ratio is higher than it is for the big banks, or even industry peer Home Capital Group Inc.
However, analysts note that Equitable's credit quality is strong, reflecting the company's focus on manageable mortgages relative to property values. Its loan-to-value ratio, or LTV, fell to 72 per cent in the fourth quarter, down from 74 per cent last year.
"We believe management continues to take a slightly more conservative approach to LTVs, which have trended lower in recent quarters," Stephen Boland, an analyst at GMP Securities, said in a note.
He added: "We like this approach and believe it may have a long run positive impact on credit quality."
Mr. Boland raised his target price on the stock to $90, up from $85 previously, making him the most bullish analyst covering the stock. Yet most of his peers also bumped up their target prices, to an average of nearly $78.
Mr. Goyn's target, published before Friday's rally, is $77: "We believe this appropriately balances the strong loan growth outlook and stable credit quality against elevated housing market and regulatory risk, including more intense housing market risks in Alberta and Saskatchewan," he said.