What are we looking for?
In speeches last week, both the Governor of the Bank of Canada as well as the Chairman of the Federal Reserve used the term “uncertainty” frequently when describing the economic unknown we are heading into. We expect tariffs to be implemented on April 2 but we do not know with certainty or at what level they may be set. How would tariffs affect Canadian bank earnings, what else is happening with bank stocks and what is that doing to bank valuations?
The screen
We used StockCalc’s screener to select the top listed Schedule 1 bank stocks by market capitalization on the TSX. (Schedule 1 means it’s a wholly domestic institution regulated by the Federal Bank Act and licensed to operate across Canada.) We then used StockCalc’s valuation tools to calculate fundamental, or intrinsic, valuation for each stock to see if it is undervalued or overvalued compared with its price.
Overview of the techniques used:
- Discounted cash flow (DCF value) is a valuation technique in which cash-flow projections are discounted back to the present to calculate value per share. For banks we use a modified DCF;
- A price comparables (price comps) technique values the company on the basis of ratios from selected comparable companies;
- An adjusted book value (ABV) is calculated by multiplying book value per share by a stock’s 10-year average price-to-book ratio.
- If a stock has analyst coverage, we may look at the consensus target price.
More about StockCalc
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What we found
Tariffs pose a number of threats to the banking sector in Canada. Economic uncertainty leads to a slowdown in activity, which results in fewer loans. That environment results in lower net interest income, higher provision for credit losses and reduced fees for the banks. In the short term, Daniel Da Silva at S&P Global Ratings sees their strong balance sheets able to withstand tariffs but under a prolonged tariff scenario the banks would need to increase their provisions for credit losses, leading to a hit on earnings.
With reduced economic activity we would expect The Bank of Canada to lower interest rates. During periods of falling interest rates, banks will make less on their interest margin (the difference between interest income and interest expense), but that is usually offset by more loans, lower loan default rates, a shift to spending and an improved housing market. The tariffs put this scenario reversal at risk with economists now forecasting a 1-per-cent to 1.5-per-cent reduction in Canadian gross domestic product (GDP) over the next 12 months.
We look at net interest margin, price-to-book (P/B) and return on equity (ROE) ratios for the banks as part of the valuation. All of the stocks on this list pay a dividend and all have seen their stock prices rise over the last 12 months. Let’s look at a couple of companies:
Bank of Nova Scotia BNS-T has five business segments: Canadian banking, international banking, global wealth management, global banking and markets, and other. In their document A New Way Forward published late in 2023, they noted the bank’s relative underperformance and announced they were focusing on growth in Canada, United States and Mexico. In looking at fiscal 2024 financials compared with 2023 results, we are starting to see improvement in net interest income and other metrics. All of our valuation data points for BNS-T are above Friday’s close price (we currently show 14 per cent upside over the next 12 months), but with April 2 looming and 78 per cent of its earnings from Canada, the U.S. and Mexico, we may need to adjust after we get tariff clarity.
On Feb. 3, National Bank of Canada NA-T completed its acquisition of Canadian Western Bank CWB-T. National Bank of Canada is the sixth-largest bank in Canada (CWB was ninth-largest) with diversified financial services including personal and commercial banking, wealth management and capital markets services. The bank is concentrated in the province of Quebec but now will have 40 per cent of its personal and commercial business outside of Quebec with the CWB acquisition. Again, all of our valuation data points for NA-T are above Friday’s close price with an expectation of 8-per-cent upside over the next 12 months.
You can see in the accompanying table the percentage difference between each stocks recent closing price and its intrinsic value. The “StockCalc Valuation” column is a weighted calculation derived from the models and Analyst target data if used.
Investing involves risk. StockCalc accepts no liability whatsoever for any loss or damage arising from the use of this analysis. Brian Donovan, CBV is the President of a Canadian FinTech based in Miramichi, New Brunswick. Brian owns shares in TD Bank.
Brian Donovan, CBV, is the president of StockCalc, a Canadian fintech based in Miramichi, N.B.