What are we looking for?
When Citibank downgraded the Canadian bank sector Monday, it referred to two main driving factors to the downgrade: compression of margins in mortgages and a slowdown in commercial loans.
It is easier said than done for an investor to avoid banks when investing in Canada. Which companies in the bank sector appear to best able to weather the forecast slowdown in loan growth and margin compression?
Today, we take a deeper dive into the sector, which has gained 11.7 per cent year to date, lagging the S&P/TSX Composite Index’s advance of 19 per cent, and analyze how well companies can withstand increased pressure on profitability.
The screen
We screened the Canadian bank sector by focusing on the following criteria:
- Market capitalization greater than $1-billion;
- A positive 12-month revenue change – a positive figure shows us that there is growth and progress in the company’s operations;
- Return on capital (ROC): The return on invested capital is the sum of the pretax earnings and interest expenses divided by the invested capital, expressed as a percentage. The highest percentage is the best ratio. The minimum threshold is set at 12 per cent.
- Economic performance index (EPI) of one and above – measuring the company’s wealth-creating ability (return on capital over cost of capital);
For informational purposes, we have also included recent stock price, dividend yield and one-year return. Please note that some ratios may be reported at the end of the previous quarter.
More about Inovestor
Inovestor for Advisors is a fundamental-analysis research platform specializing in the economic value-added (EVA) approach. With Inovestor, advisers can quickly identify attractive investment opportunities, outsource their stock picking by using model portfolios, and easily communicate investment decisions with clients through client-friendly reports. In addition, Inovestor allows users to create personalized filters, build custom portfolios and carry out in-depth analysis on more than 13,000 companies (Canadian stocks, U.S. stocks and American depositary receipts).
What we found
Ranked by ROC, the top four on our list includes three banks (National Bank of Canada, Royal Bank of Canada and Equitable Group Inc., which owns Equitable Bank) and one mortgage-lending company (First National Financial Corp.) First National tops our list with an impressive ROC of 35.2. Both First National and Equitable had more than 20 per cent growth in sales in the last fiscal year. They both offer the least exposure to commercial loans on our list.
As for the Big Six, RBC and National Bank of Canada performed better this year than their peers and look better positioned to withstand the expected margin pressure as their ROC is stronger. National Bank and Canadian Imperial Bank of Commerce have higher relative exposure to Canadian commercial loans. Bank of Nova Scotia trails behind the other big banks in ROC at 12.9 per cent, well below the sector average of 15.1 per cent for 2019.
Investors are advised to do further research before investing in any of the companies shown here.
Christian Godin is a portfolio manager at Inovestor Asset Management.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.