Today we are continuing on with Part 2 of our interview with Bruce Campbell of Campbell & Lee Investment Management. With the financial sector making up 28.95% of the S&P/TSX Composite, in the ensuing interview, you’ll find out Bruce’s thesis for owning CIBC also known as the Canadian Imperial Bank of Commerce (NYSE:CM).
Biography: Bruce Campbell is a widely respected professional money manager with over 35 years of experience in the investment industry. Bruce was a senior vice president with Royal Trust, a wholly-owned subsidiary of the Royal Bank, managing over ten billion dollars of Canadian and US equity money for pension plans and mutual funds. The team was acknowledged by independent measurement services as being one of the top investment performer in the country over a ten year period. In 2000, Bruce co-founded Campbell & Lee Investment Management Inc. where he currently provides investment services to a wide variety of high-net worth clients. Bruce has a B.A. and M.A. in Economics.
Q: Can you start off by telling us a little bit about CIBC and why you prefer it over the other major Canadian banks?
A: Canadian Imperial Bank of Commerce is the fifth largest bank in Canada in terms of assets. CM operates two strategic business units: CIBC Retail Markets (includes wealth management and FirstCaribbean) which provides financial products and services to personal and small business customers and CIBC World Markets (the wholesale and corporate banking operations) which offers a full range of investment banking products.
CIBC is the smallest of the big five Canadian banks by market capitalization. It was hit the hardest during the financial downtown in 2008, when it was exposed to billions of dollars in losses associated with the subprime crisis in the United States.
Q: What about valuation? How does CIBC’s valuation compare to its peers? In your estimation, when do you think CIBC will increase its dividend?
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A: We think that the discount that the market applies to CM’s earnings is too high and believe it will decline over the next year as the bank delivers a fairly stable level of repeatable earnings from a retail business mix and a higher than average capital position. Given their earnings outlook and capital ratios, CM should be able to raise their dividend in early 2011.
Q: With the higher capital requirements stemming from Basel 3, some of the analysts covering banks have said that every 100 bps increase in tangible common equity would reduce ROE by approximately 130 bps on average for the Big Six banks. What are your thoughts on this and do you think that banks valuations in general and in turn those of CIBC will compress as a result of this and the impact of low interest rates?
A: Higher capital ratios for Basel 3 will impact the ability to raise dividends as quickly as they would have done historically. Even so, as payout ratios come down towards 40% next year, small increases will happen. Bank valuations in Canada are healthy with the group at roughly 2.5x book value which is historically high.
Q: Given the backdrop of a slowing economic recovery and housing market and with new regulatory requirements putting a big premium on core common equity capital, share buybacks and cash acquisitions are likely to be muted in the future, where do you see CIBC’s earnings and growth coming from in the future?
A: CIBC like many of the banks, recognizes that the North American market will grow at a very slow pace over the next few years. However, they find themselves in a great position to take advantage of international opportunities. With bond yields at record lows, note the recent 1.5 billion dollar capital raise by CIBC that is paying just slightly over 3%. With yields like these, it means banks can easily raise capital for acquisitions, or expansion of their business beyond North American borders to attempt to benefit from growth overseas. CIBC has its Caribbean business that should grow at an above average rate. Also, the recent purchase of Citigroup’s Canadian Mastercard portfolio provides a new avenue of growth.
Q: What catalysts do you see that could move CIBC’s stock price?
A: Potential catalysts for CIBC include:
- Canadian economy recovering further will translate into higher bank stock prices.
- Acquisition/expansion into new areas as mentioned above (international, credit card, etc.) will drive earnings and therefore the stock price. In CM’s case, execution of the simple plan laid out by management could raise the multiple from below-average to above which would help drive the stock higher.
- A dividend increase would directly impact the stock.
Q: How much weight are you assigning to the company’s management in your investment thesis? Have they performed upto your expectations till this point?
A: It is a high weight because past execution for this bank has resulted in the below average valuation. This becomes the opportunity now as the new team appears to have a simple plan and have not stumbled yet.
Q: What are some of risks that could hamper your investing thesis?
A: Possible weakness in the Canadian housing market going forward would impact all banks.
There is still a very small risk of a double dip recession. This would result in limited growth in Canada (further weakness in the economy). Canadian consumer debt would get worse and loan losses would rise. If the bank cannot deliver a fairly stable, and growing, level of repeatable earnings, investors holding CM common equity would not be rewarded with a fairly predictable pattern of steadily rising common share dividends. The multiple would therefore stay depressed under that scenario.