UBS Analyst Forecasts an 18% Return on Canadian Bank Stocks in 2008

As the Canadian economy continues to show signs of health despite weakness in the U.S. and fears of a recession there, many investors are wondering if Canada’s bank stocks have bottomed. The seemingly endless string of writedowns from global banks has produced what many consider the most challenging environment for the sector in a long time.

But one of the key factors that could boost valuations for banks later this year – particularly in Canada – is lower interest rates. However, the credit concerns that have caused much of the recent pain for Canadian financials isn’t going anywhere, according to UBS analyst Peter Rozenberg.

With this in mind, he suggested that while the price-to-earnings ratios for Canada’s banks are good at 11 times, they not great. His target is 12 times.

Nonetheless, he expects Canadian bank stocks will produce an average one-year return of 18%. Earnings per share growth is expected to be 3% in 2008, compared to the consensus estimate of 4% and management guidance of 5% to 10%, he noted.

Mr. Rozenberg said in a report that:

Liquidity is good, CDO/monoline exposure is measured (except at CIBC), and asset quality remains strong. However, capital markets, which are 29% of EPS, and loan growth are expected to decline.

At the same time, the weak U.S. outlook, and low and rising provisions mean the recent volatility will likely continue.

Mr. Rozenberg, who recently took over the banking beat from Jason Bilodeau, who moved to TD Newcrest, considers Toronto-Dominion Bank (TD) and Bank of Nova Scotia (BNS) to be in the best position in terms of sustained growth and low risk, and rates them a “buy,” while Royal Bank (RY), Bank of Montreal (BMO), CIBC (CM) and National Bank [NA.TO] are all rated “neutral.”

The analyst said he prefers names with high property and casualty, and emerging markets exposure, along with lower vulnerability to the capital markets.

TD vs. BNS vs. RY vs. BMO vs. CM 1-yr chart: