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Summary

  • RBC exceeded its earnings estimates for FQ3, and raised its dividend.
  • The company is undervalued as compared to its industry and the broader market.
  • Overall, RBC looks like a solid dividend-paying investment for the long term.

Results for FQ3

Canada's largest bank in terms of assets and market-cap, Royal Bank of Canada (NYSE:RY), exceeded its earnings estimates for FQ3. The company achieved record earnings of $2.3 billion, or $1.64 per share, for the quarter, which exceeded estimates by $0.06 per share, or 5%. This was the company's third quarter in a row where it beat its earnings estimates. This represented a 10% increase over Q3 of last year when excluding the loss related to the closing of RBC Jamaica this year and a tax item from last year. Record earnings were achieved for the following businesses: Canadian banking, capital markets, wealth management, and insurance.

There was a 10% increase in checking account balances in Q3. Wealth management earnings increased 20%, which reflected higher fee-based client assets across all businesses. Capital markets achieved a record quarter with earnings of about $640 million, exceeding RBC's expectations. Insurance also had a record quarter with positive actuarial reserve adjustments and an improved claims experience.

The company's strong performance is a reflection of RBC's focus on clients and the ability to manage capital and costs effectively. RBC remains nimble to adapt to its clients' needs and to the changing market. Therefore, I think that the company can build on this positive momentum and grow effectively going forward.

RBC raised its dividend by 6% for a quarterly payment of $0.75 per share. The stock currently pays a dividend of 3.6% on a 47% payout ratio. The company raised the dividend every year since 2011. I think that RBC is likely to continue raising the dividend, as it continues to perform well in North America. RBC has a diverse set of offerings, including personal and commercial banking, wealth management, insurance, investor & treasury services, and capital markets. So, I think that RBC is positioned well to increase earnings over time, which will allow the company to make future increases in dividend payments.

Valuation

At first glance, RBC looks fairly valued, as it trades at 11.4X next year's expected EPS of $6.47. The money center banking industry trades with the same multiple. However, RBC is slightly undervalued in terms of its 5-year expected average earnings growth. RBC trades with a PEG of 1.57, which is below the industry's PEG of 1.79. Since the S&P 500 is trading with a forward PE of 16.6, I consider RBC undervalued in terms of the broader market.

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Outlook for the Stock

Analysts are expecting revenue to increase 4.9% to $32.4 billion for the fiscal year 2014, which ends in October. Revenue is also expected to increase about 4.9% to nearly $34 billion for FY15. EPS is expected to grow 11.6% this year and 6.8% next year. If we take the expected FY15 EPS of $6.47 divided by the current price of $73.73, the inverted PE implies about 8.8% growth for the stock. This would bring the stock price to over $80 by the end of FY15. In the meantime, investors will also collect the dividend payments, adding to their gains.

There has been some chatter about a bubble in the Canadian housing market and that the banking industry is at risk. However, I don't think that there is much validity to that theory. Housing prices in Canada may be high, but there is not a subprime lending issue that would lead to a collapse. The more likely scenario would be that housing prices level off if prices become too high in relation to incomes. RBC should continue to perform well, as it offers a diverse set of financial products.

Source: Royal Bank Of Canada: A Solid Dividend-Paying Investment