Royal Bank of Canada (TSX: RY) is the biggest bank in Canada. Moreover, it is one of the 15 largest global banks in the world in terms of market capitalization. The bank, through its wide array of products and services serves about 17 million customers across 36 countries. The bank primarily operates through five operating segments including, Personal & Commercial Banking, Wealth Management, Insurance, Investor & Treasury Services, and Capital Markets.

Investment thesis:

• Play the recovery with RY stock: Shares of Royal Bank of Canada are down about 14% so far this year. Tough operating environment amid the rapid spread of COVID-19 cases led investors to dump bank stocks. In the near-term, RY stock could feel pressure as weak economic outlook, low-interest-rate environment, and higher provisions are likely to weigh on the earnings of the bank. However, being the largest Canadian bank, we expect shares of Royal Bank of Canada to show a recovery. The bank’s strong underwriting practises, diversified business, and sufficient capital and liquidity position will help it to sail through the current crisis. Further, we expect Royal Bank of Canada stock to witness strong recovery, reflecting the benefits from the sharp resurgence in credit offtake once the economy normalizes.

• Strong balance sheet, prudent risk management: A continued growth in loans and deposits and prudent risk management makes Royal Bank of Canada an attractive long-term pick. The bank’s loans have grown at an average of more than 7% since FY15 despite competitive pressure. In 2019, the group witnessed strong growth in volumes with the average loan and deposit growth of ~6% and 10%, respectively. Further, the bank’s loan portfolio is fairly diversified with residential mortgages forming about 48% of the total loan, wholesale accounting for 34%, personal loans representing 14%, credit cards 3%, and small businesses accounting for 1%. In the near-term, we could see a decline in the loan origination and growth rate. However, the bank remains well-positioned to drive its loan book once the economy picks up pace. The bank’s balance sheet expansion is backed by strong underwriting practises and prudent risk management, which led to stable credit trends. During the first quarter of FY20, Royal Bank of Canada reported lower provisions for credit losses (or PCL), with a total PCL on loans ratio of 26 basis points. Moreover, PCL on impaired loans ratio came in at 0.21%, reflecting an improvement of about 6 basis points. Also, the total GIL ratio improved by 1 basis points to 0.45%.

• An ideal stock for income-seeking investors: Royal Bank of Canada is an ideal stock for investors seeking steady income in the long run. The bank has a long history of rewarding investors through higher dividends and share repurchases. Royal Bank of Canada’s dividends increased by a CAGR of 7% since 2009, thanks to the bank’s ability to generate consistent earnings growth. In FY19, Royal Bank of Canada returned 55% of its profits to its shareholders in the form of dividends and share buybacks. Meanwhile, RY paid dividends worth CAD 5.8 billion in FY19 with the dividend payout ratio of 46%. Despite the current crisis, we don’t expect any cut in the payout. RY targets a payout of 40%-50%, which we believe is sustainable in the long-run. In the first quarter of FY20, Royal bank of Canada increased its quarterly dividend by 3% to CAD 1.08 per share. In the first quarter, RY returned CAD 2.2 billion to its shareholders, including CAD 1.5 billion in the form of dividends. RY’s current dividend yield stands at 4.9%, which looks lucrative.

 

Dividend History (Source: Company Reports)

Q1FY20 Operational Highlights: Royal Bank of Canada had a stellar start to the current year with sustained growth in loans and deposits. Besides, lower provisions supported the double-digit growth in the first quarter bottom line. The bank reported total revenues of CAD 12,836 million in the first quarter, up about 11% year-over-year. Higher net interest income led by growth in loans and deposits supported the top line growth. Moreover, higher insurance premiums, increase in investment and fee income and higher underwriting and other advisory fees supported total revenues.

Revenue Details (Source: Company Reports)

Higher NII: Net interest income (or NII) increased 8% year-over-year to CAD 5,221 million. Volume growth in the Canadian Banking and Wealth Management segment and strong client activity in the Capital Markets segment supported the growth in net interest income. Also, higher revenues in the Investor & Treasury Services business drove NII further. Despite higher NII, net interest margin (or NIM) fell one basis points to 1.59%, reflecting changes in the average earning asset mix.  

Decline in PCL: Total provision for credit losses or PCL decreased 18% y-o-y to CAD 419 million, thanks to the lower provisions in the Capital Markets and Wealth Management segment. PCL on loans as a percentage of average net loans and acceptances improved 8 basis points to 0.26%.

Provision for Credit Losses (Source: Company Reports)

Improved efficiency ratio: Non-interest expense increased 8% year-over-year to CAD 6,378 million, reflecting higher variable costs and investments in digital initiatives. Efficiency ratio improved to 49.7% from 51.0% in the prior-year period.

Efficiency Ratio (Source: Company Reports)

Double-digit earnings growth: Royal Bank of Canada posted net income of CAD 3,509 million, up 11% year-over-year. Higher revenues, lower provisions, and improved efficiency drove the bottom line growth.

By segments, net income in the Personal & Commercial Banking rose 7% year-over-year to CAD 1,686 million, driven by growth in average loans, primarily in the residential mortgages. However, lower spreads, increased investments in digital initiatives remained a drag. Capital Markets segment posted net income of CAD 882 million, up 35% y-o-y. Higher M&A activity and an increase in fixed income trading revenues across all regions supported net income growth. Also, a decline in provisions further propelled the bottom line.

Net income in the Wealth Management segment increased 4% y-o-y to CAD 623 million. Higher transaction volumes and an increase in average fee-based client assets supported the bottom-line growth. Insurance segment marked a 9% y-o-y growth in net income to CAD 181 million, reflecting new longevity reinsurance contracts. Investor & Treasury Services reported net income of CAD 143 million, down 11% y-o-y, reflecting lower client deposit margins and a decline in revenues from its asset services business.

Strong Balance Sheet: Total assets stood at CAD 1,476,304 million, driven by higher loans. Loans (net of allowance for loan losses) increased 6.8% year-over-year, reflecting growth in residential mortgages and wholesale loans. Total deposits also rose ~6%, driven by an increase in retail deposits, and higher issuances of fixed-term notes. The bank’s capital position remained strong with Basel III CET1 ratio of 12.0%.

Financial highlights (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 19.18% of the total shareholding. RBC Global Asset Management, Inc. is the entity holding maximum shares in the company at 3.08%. The Vanguard Group, Inc. is the second-largest shareholder, representing a holding of 2.93% in the company.

Top Ten Shareholders (Source: Thomson Reuters)

Key Metrics: Royal Bank of Canada’s net interest margin showed sharp improvement in FY19, thanks to the strong growth in loans and deposits. The loan growth rate for FY19 stood at 7.3%, higher than 6.3% in FY18. The deposit growth rate for FY19 stood at 5.8%, slightly below 6.0% growth in FY18. The bank remains strongly capitalized as Tier 1 risk-adjusted ratio stood at 13.2%, higher than 12.8% in FY18.

Key Metrics (Source: Thomson Reuters)

Key Valuation Metrics (Source: Thomson Reuters)

Valuation Methodology (Illustrative)

Price to Book Multiple Approach 

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: Royal Bank of Canada stock closed at CAD 88.25 with a market capitalization of CAD 126.25 billion on 9 April 2020. The stock made a 52-week low and high of CAD 72.00 and CAD 109.68. RY is one of the biggest banks in the world and looks fundamentally strong despite the challenging operating environment in the near-term. The bank’s strong capital and liquidity position will enable it to weather the current crisis easily and bounce back strongly when the economy picks up pace. The bank’s balanced portfolio of loans and well diversified business provides a strong underpinning for growth. We do see challenges in the near-term, but the correction in RY stock presents a good entry point to buy the stock for long-term. Investors should note that the group continues to boost shareholders’ return through higher dividends and is not expected to cut dividends in 2020 despite challenges. The current dividend yield stands at 4.9%, which looks attractive. Notably, RY stock has historically traded at a premium, when compared to its peers. The bank’s premium valuation seems justified, given the consistent growth in loans and deposits, solid risk management practices, and healthy dividend yield. RY stock trades at a forward P/BV ratio of 1.53x, which is above the peer group average of 1.16x. We expect the multiple to expand in the coming quarters as the economy recovers. We have valued the stock using Price to Book based relative valuation method with a target multiple of 1.8x. For this, we have considered peers like Canadian Imperial Bank of Commerce (TSX: CM), Bank of Montreal (TSX: BMO), Toronto-Dominion Bank (TSX: TD), Bank of Nova Scotia (TSX: BNS) etc., and arrived at a target price which implies a lower double-digit upside (in % terms).  Hence, we give a ‘Buy’ recommendation on the stock.

 

RY One-Year Daily Price Chart (Source: Thomson Reuters)

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Disclaimer

 

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