National Bank Of Canada: Value Trap Or Value Play?

| About: National Bank (NTIOF)

Summary

NB's Q1 EPS was ahead of consensus driven by trading and Credigy.

P&C, capital market, and wealth all came in better than expected.

Higher than peers ROE and a 20% discount in PER warrants attention but could potentially be a value trap. Prefer RY and TD.

National Bank of Canada (OTCPK:NTIOF) reported Q1 adjusted EPS of $1.17 vs. consensus $1.15. The beat appears to be mostly driven by strong capital market trading revenue, higher than expected revenue from Credigy and Canadian banking. Given NB's predominant exposure to the Canadian economy, it was interesting to see how the bank was able to grow Canadian banking earnings by +8% on the back of a +7% loan growth. At the current multiple of 8x forward earnings, NB looks very cheap relative to the peer group of 10-11x. Additionally, NB's ROE of 16.5% is also higher than its peer group.

Although I am skeptical of its exposure to the Canadian economy, I think value investors could consider adding NB to their portfolio on valuation grounds. However, the risk is that a weakening Canadian economy due to the deterioration of the energy market could further weigh in on NB's valuation. For the more conservative investor base, my picks are Royal Bank (NYSE:RY) and Toronto-Dominion Bank (NYSE:TD) given their market dominance and global exposure. Also worth mentioning, BMO (NYSE:BMO) is starting to look interesting for growth investors but valuation remains rich vs. peers.

Canadian P&C earnings grew +8% driven by +5% in revenue. Average loan growth of +7% was solid with personal loan growth of +6% and commercial loan growth of +9%. Positive operating leverage added to the earnings growth. Retail NIM was down 3bps to 2.22% from the prior quarter. Unlike the other Canadian banks that have non-Canada exposure, NB's P&C business is entirely Canadian and this poses a risk in a scenario where the Canadian economy weakens further. This is also why NB is ranked last in my pecking order among the six Canadian banks. In short, I remain cautious in this segment given the potential shock it could experience.

Financial markets earnings were up +2% when we exclude non-controlling interest driven by strong trading revenue and results from Credigy. Trading revenue of $227m was above the $208m from the prior quarter driven mostly by equity trading while fixed income trading was roughly flat. Credigy, which owns and manages portfolios focusing mainly on U.S. based distressed consumer receivables, generated $103m in revenue vs. $70m from the prior quarter to reflect the revaluation of the portfolio that beat the company's expectations.

Finally, wealth management earnings grew +4% as AUA was down 33% while AUM was up 7%.

Conclusion, NB's only selling points are its higher than peer ROE and lower than peer P/E multiple. However, the stock is cheap for a reason given the potential weakness of the Canadian economy. I would stick with TD and RY as two safer Canadian banks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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