Scotia Bank (TSX: BNS) is a leading bank in North America and has tremendous market presence across Canada. The Group also operates across the markets of Mexico, Peru, Chile and Colombia. BNS group offers an array of financial and banking services which includes wealth management and banking solution. The bank also provides banking services like lending, deposit, cash management and trade finance solutions to the medium and large businesses. Other banking services include debit card & credit services, mortgages and loans, investments etc.

Investment Rationale:

• Diversified business with lower risk profile: Bank of Nova Scotia has a diversified presence and generates revenue from several countries like Canada, US, Mexico, Peru, Chile and Colombia. The Bank has lowered its operational risk with more focused geographic footprint. The group is focusing on increasing share within the core markets through innovating its digital banking presence, better risk management and improved funding. Amidst, the current macro volatility, BNS successfully reported higher net interest income driven by strong asset and deposit growth, which stands out the Company from the competition.

• A friend of income investors: BNS has a solid history of dividend payment, which is an important factor for income-seeking investors with a long-term horizon. At the current market price, the BNS stock is offering an attractive dividend yield of ~6.52%. During FY09 to FY19, the Group has reported a CAGR of 6% in its dividend distribution with a payout ratio of 52% in FY19. During the current quarter, the Management announced a dividend of CAD 0.90 per common share, higher than CAD 0.87 in pcp, which is encouraging looking at the current market dynamics. The group is targeting to maintain its dividend payout ratio in the range of 40%-50%.

 

                              

Snapshot of the historical performance of Dividend and EPS (Source: Company Reports)

• Strong capital base: At the end of Q2FY20, the Bank’s CET1 Capital Ratio stood at 10.9% versus 11.4% in the previous quarter. The marginal decline was primarily attributable to an internal capital generation, which was offset by higher drawn balances in corporate and commercial lending, counterparty credit risk and credit valuation adjustment risk-weighted assets. BNS maintained Tier 1 and total capital adequacy ratios at 11.9% and 14.0%, respectively during the quarter. Meanwhile, the Bank reported a leverage ratio of 4.4%, reflecting an improvement of 0.4% from the previous quarter. Amidst the current downturn, the Bank was successful in maintaining its CET1,Tier 1 and total capital adequacy ratios well above the Office of the Superintendent of Financial Institutions, Canada (OSFI's) minimum requirement, which is commendable. 

• Higher provisioning would provide cushion to absorb any hiccups: Due to the ongoing business challenges and slide in retail spending coupled with higher unemployment, the group has created a provision for credit losses of CAD 1,846 million, against CAD 873 million in pcp. Though the higher provisioning has taken a toll on the profitability, it is likely to provide a cushion against the future setbacks if default rises. The group has adopted a conservative approach to making higher provisions.

Q2FY20 Financial Result:  

BNS declared its quarterly results, wherein the Company reported an improved top-line of CAD 7,956 million, as compared to CAD 7,803 million in Q2FY19, aided by decent growth in the net interest income. Provision for credit losses increased to CAD 1,846 million, from CAD 873 million in pcp, primarily attributable to higher provisioning for credit losses within the Canadian banking and international banking segment. Non interest expense came in at CAD 4,363 million compared to CAD 4,046 million in pcp. Net income declined to CAD 1,324 million compared to CAD 2,259 million, primarily affected by higher provisioning.

Q2FY20 Income Statement Highlights 9Source: Company Reports) 

Segment Highlights: BNS operates across four lines of business which are Canadian Banking, Global Banking and Markets, International Banking and Global Wealth Management.

Segment Highlights (Source: Company Reports)

Canadian Banking: This segment reported a revenue of CAD 2.5 billion, remained flat on y-o-y basis. Average loans reported at CAD 355 billion, reflecting a healthy growth of 7% on y-o-y. The segment reported a ~200 bps improvement in the productivity ratio at 48.1%, which is encouraging. Provision for credit losses increased 165% over pcp, while PCL rate increased 46 bps to 0.77%. Total average assets and total average deposits were up 7% and 4%, respectively on y-o-y basis. Due to higher provisioning, net income slide by 42% to CAD 481 million. The Group is focusing on to retain its productivity ratio at below 44% and targets a net income growth of 5% in the medium-term. Canadian Banking segment contributes ~36% of the total BNS’s earnings.

              

Q2FY20 Performance Highlights, Canadian Banking Segment (Source: Company Reports)

Global Banking and Markets: BNS provides lending, transaction services, investment banking advice solutions to capital markets through the Global Banking and Markets segment to its corporate clients. The segment contributed ~26% to the group’s net earnings. The average loan from the segment grew ~20% over pcp, while deposits recorded a growth of 33% at the same time. Despite a volatile equity market, the segment reported a solid top-line and bottom-line growth of 27% and 25%, respectively on y-o-y basis. The segment reported solid growth of 20% in its average assets. The productivity ratio improved 940 basis points to 42.2%.

Q2FY20 Global Banking Performance Highlights (Source: Company Reports) 

International Banking: The Bank derived ~21% of its revenue from the International Banking division. The segment reported an annual decline of 9% in its revenue to CAD 2.7 billion, while net income fell 72% to CAD 197 million. The segment’s average loans recorded an annual growth of 6%, while deposits grew by 3% on y-o-y basis.

Global Wealth Management: BNS provides integrated wealth management advisory services through the global wealth management segment and derived ~17% of its Q2FY20 net earnings from this segment. Revenue from the segment grew marginally (~1%) to CAD 1.1 billion, while net income grew ~3% to CAD 314 million. Productivity ratio improved by 90 basis points to 61.9%. The assets under administration declined 3% to CAD 477 billion while assets under management declined 6% to CAD 278 billion.      

A Recap to FY19 result: For the financial year ending 31st October 2019, BNS’s revenue increased to CAD 31,034 million, as compared to CAD 28,775 million in FY18, driven by growth in interest income and non-interest income. Provision for credit losses grew to CAD 3,027 million from CAD 2,611 million in FY18. Net income stood at CAD 8,798 million, up marginally from CAD 8,724 million in the previous financial year. Net interest income grew modestly to CAD 17,177 million, from CAD 16,191 million in FY18. Productivity ratio increase to 53.9% as against 52.3% in FY2018. The Bank’s CET1 ratio remained stable at 11.1%. Total assets were reported at CAD 1,086,161 million, increase from CAD 998,493 million in FY18. The Bank’s core Banking margin stood at 2.44%, down 2 bps from FY18, due to change in business mix.

FY19 Income Statement 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 3.90%, while RBC Global Asset Management Inc. holds 3.69%. The Vanguard Group, Inc. is the third-largest shareholder, representing a holding of 3.11% in the Company.

Top Ten Shareholders (Source: Thomson Reuters)

Valuation Methodology: Price to Book Based Relative Valuation (Illustrative)

P/BV Multiple Based Approach (Source: Refinitiv, Thomson Reuters)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Outlook: The Bank has Strong balance sheet, capital and liquidity ratios. The bank is focusing on gaining traction in its six core markets of Canada, US, Mexico, Peru, Chile and Colombia. The bank possesses Strong risk management culture within the Canadian region while the business continues to emphasize on high levels of technology investment to support digital banking strategy to enhance its sales. Due to the COVID-19 pandemic, we expect the equity market to remain volatile, which might hinder the company’s investment and wealth management segments for a while.  Since most of the monetary authorities have lowered the interest rates, the bank’s net interest margin is likely to remain under pressure in the near term, but this opens up an opportunity for the bank to expand its loan book in the medium term. 

Stock Recommendation: The Stock of BNS corrected ~24% so far this year due to the worldwide disruptions in business on account of COVID 19 crisis. Due to the short-term economic jolt, most of the banks and financial institutions are struggling with its loan and deposit growth and maintaining minimum capital ratios. BNS has reported decent growth in its loan and deposit and maintained the capital adequacy requirement amid the challenging operating environment. The bank is expanding its digital footprint to drive growth and focusing on investing in high ROE businesses. Investors should note that the group is deriving ~75% of its earnings from a stable Personal and Commercial Banking and Wealth Management Segment and the group was named ‘Bank of the Year’ in 2019. Most of the bank’s loans are high grade or secured, which is likely to protect the bank from the default risk in the challenging environment. The group remain well-positioned from a capital and liquidity perspective. The group is consistent in dividend distribution and is offering a dividend yield of 6.52%, which is attractive amid the lower interest rate environment. The stock appreciated ~7% in the last five trading sessions and was trading above its 20 days and 50 days simple moving average of CAD 53.00 and CAD 53.83, respectively, indicating a short-term bullish pattern. We have valued the stock using Price to Book based multiple based relative valuation method and have arrived at a target upside of double-digit (in percentage terms). For the said purposes, we have considered peers like Canadian Imperial Bank of Commerce (TSX: CM), Bank of Montreal (TSX: BMO), Royal Bank of Canada (TSX: RY) etc. Hence, we recommend a ‘Buy’ rating on the stock at the current market price of CAD 56.17 on June 1, 2020.

BNS Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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