A Royal Way to Bank on Canada

12/10/2015 10:00 am EST


Chloe Jensen

Chief Analyst, Cabot Dividend Investor

Energy companies make up a big part of the Canadian economy, so the past year of declining oil prices has weighed heavily on Canada’s bank stocks, observes Chloe Lutts Jensen, income expert and editor of Cabot Dividend Investor.

High quality Royal Bank of Canada (RY) offers good value, a generous yield, an emphasis on dividends, solid net income growth, and the best operating margins of the group.

Royal Bank of Canada has paid dividends for 20 years. Management has increased the dividend nine times in the past five years, averaging an annual dividend growth rate of nearly 10%.

The current payout ratio of 46% is in line with the bank’s historical average and typical payout ratios in the financial industry.

RY’s dividends are declared in Canadian dollars, so US investors will see some variation in dividends because of exchange rate changes.

In recent years, Royal Bank of Canada has pursued growth primarily by expanding its offerings beyond retail banking.

The bank now has operations in wealth management, insurance, capital markets, and treasury services for institutional investors, as well as personal and commercial banking.

Today, personal and commercial banking accounts for 52% of earnings, followed by capital markets at 23% and wealth management at 11%.

In January, Royal Bank bought US-based City National (CYN)—a private and commercial bank—to expand its wealth management and capital markets presence south of the border.

Approximately 19% of revenues now come from the US, 18% from other international markets, and 63% from Canada.

Over the past 12 months, Royal Bank of Canada has delivered the second best return on equity and best operating margins among the Big Five Canadian banks.

Since 2009, net income has grown by 18% per year on average. Going forward, analysts expect EPS growth to reach 7% this year (in US dollars) and average over 8% over the next five years.

RY reported fourth-quarter and full-year 2015 results on December 2 before the market opened.

After declining 18% over the past 12 months, RY now trades at a P/E of 11.5 and a forward P/E of only 10.9.

The stock’s current yield of 4.2% is also about half a % above its five-year average yield of 3.7%, another indication that the stock is undervalued.

There is some risk that the downtrend in Canadian banks isn’t quite over. However, the shares have been quite stable over the past month, despite a renewed slide in oil prices to their lowest level since August.

For long-term income investors, RY presents a good opportunity to buy a high quality dividend-prioritizing stock at a good value.

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