In this article, I'll have a closer look at the Bank of Nova Scotia (BNS) ('Scotiabank'), which just reported results for its fourth quarter of 2013. As Canadian banks have the reputation to be quite reliable, I will see if Scotiabank indeed has a solid business model. I will provide my view on the company's financial results and its balance sheet, and I will briefly talk about my outlook for BNS. This will result in my investment thesis at the end of this article.
The Bank of Nova Scotia reports its financial statements in Canadian Dollar, and I used an USD/CAD exchange rate of 1.06 to recalculate the numbers into USD.
My view on the financial results
In the fourth quarter of this year, Scotiabank reported a net profit of C$1.7B ($1.6B) or C$1.30 ($1.225)/share, which is a 10% increase (in EPS, and a 12% increase in net profit) from the same period of last year. This means that on an annualized basis, Scotiabank is currently trading at a Price/Earnings ratio of 12.2, which is in line with its peers in the Canadian bank sector. The profit increase was in line with the revenue increase of 11% (of which 1/3rd is attributable to the acquisitions Scotiabank made earlier this year).
The return on equity [ROE], however, was 'just' 15.7%, which is a tad lower than the 16.4% in the same period last year and the excellent 19.7% for the entire year 2012.
The net interest income for the last three months of the year was a very respectable C$2.88B ($2.72B), which accounts for just over 25% of the yearly net interest income, and is a 11.6% increase compared to the same quarter last year. Total revenue was C$5.4B ($5.1B) which is 11% higher than the same period last year, and almost all divisions of the company booked a moderate to strong revenue growth, except for the underwriting division which saw its revenue slip by 7.5%, but this is nothing to worry about, as the first nine months of the year were extremely strong for the underwriting business, with a revenue growth of 5.5% compared to last year.
My view on the balance sheet
Most investors in the financial sector seem to focus on the book value of banks these days. That's not very good news for people who would like to invest in Scotiabank, as the book value per share is just C$33.57 ($31.67). This means the company is currently trading at 1.9 times its book value which is quite expensive for a North American bank.
I do realize that Scotiabank is relatively expensive, because Canadian banks have an excellent reputation, and Scotiabank is in quite a strong position with its Common Equity Tier 1 ratio (under Basel III standards) of 9.1% which is a relatively big increase from 8.9% at the end of the third quarter. This increase was mainly caused by making it possible for investors to elect a dividend in shares instead of in cash, which allows the Bank of Nova Scotia to incorporate more reserves to strengthen its balance sheet.
The management team doesn't provide an in-depth guidance for 2014, but is hinting at a continuing growth. As such, I'm guesstimating a net profit increase per share to $5.10 (assuming 50% of the dividends are being reinvested in new shares) and assuming a continuous Return on Equity of at least 15% and no higher provisions for bad loans.
Scotiabank isn't cheap with a 12.2 price/earnings multiple and a price/book value of 1.9. As such, this isn't an investment for faint-hearted investors who are scared of a collapse of the Canadian housing market. I'm personally happy with the company's relatively strong balance sheet and the continuing strengthening of the capital ratios by letting investors choose between a cash dividend and a dividend in shares.
As such, I would prefer to invest in the Bank of Nova Scotia's preferred shares (which don't provide any upside potential, but have a fixed dividend if you're an income investor). If you are looking for value, I would recommend to consider writing a put option at a strike price lower than the current share price in order to purchase BNS at a lower P/E and P/B. I'm particularly looking at a P50 June 2014 at $0.55. If BNS expires under the strike price, I will very likely get shares assigned at $XX which means I'm buying Scotiabank at a forward P/E 2014 of 10 and a P/B of 1.5 with a dividend yield of 4.7%. If BNS expires higher than the strike price, I'll keep the option premium of $0.55, which results in an annualized yield of 2%.