Royal Bank Of Canada (NYSE:RY) has produced a lot of fear in investors as of late, as the stock tanked -17% last year. A lot of short sellers have taken it to RBC, as well as the other Canadian banks. I believe this is a mistake consider once the Canadian economy recovers, RBC presents a fantastic buying opportunity because its valuation is the lowest its been in many years. The fundamentals are still present, and the dividend is one of the strongest on the stock market. RBC has the second largest exposure to oil and housing, of the big five Canadian banks, only second to CIBC (NYSE:CM). Although RBC has a considerable amount of exposure to Alberta, it is important to note that this is not as bad as it sounds considering RBC has very little direct exposure to the oil patch, and a lot of its mortgage loans are insured by the CMHC (Canadian Mortgage and Housing Corporation) against a housing meltdown. Investors looking to capitalize on the rebound in Canada's economy will do very well with RBC's shares as we head into the latter part of 2016.
Fears over oil weakness and a housing meltdown are unjustified
The CMHC reported that 9 out of 15 cities that it monitors are currently extremely overvalued. In cities like Toronto and Vancouver, the housing market looks to have reached a bubble that may burst in the next few years. There is huge pessimism for Canadian bank stocks because of the inflated housing market, for RBC in particular. Of the Canadian banks, RBC has the largest exposure to mortgages in B.C. and Ontario, which consists of 21% of its loan portfolio. While pundits such as Kevin O'Leary don't believe that the housing market will violently correct, it is almost guaranteed that the housing market will do not better than remain flat for the next few years.
When looking at oil, RBC has a very small amount of exposure, as it currently consists of 1.6% of RBC's loan portfolio at $8.4 billion. Of these loans, only 18% are to refining firms, which are the ones that are most stressed when oil prices head south. Although the direct exposure to oil and gas is low, RBC has quite a large exposure to Alberta, as it accounts for 19% of Alberta's loans. If the Canadian economy continues to suffer, Alberta in particular, RBC will feel the most pain of the big five Canadian banks due to its high Albertan exposure. Oil has rebounded quite a bit from its low of $26 earlier this year, as crude is currently at $49 and looks to be gathering positive momentum. The increase in oil prices lowers the possibility of defaults for oil firms, and Albertan mortgage defaults. Both of which are a fantastic sign for RBC. I believe oil will continue rallying, and RBC will soar higher with it. If you're an American investor, now might be the time to invest in a name like RBC, as many pundits believe that the TSX will outperform the S&P 500 in 2016, for the first time in over five years.
RBC is not as well diversified as some of its peers in the Canadian banking scene. TD Bank (NYSE:TD), which is Canada's most diversified bank has a big portion of its loans based in the U.S., whereas RBC only has 8% of its loans here. However, unlike TD Bank, RBC has 7% of its loans outside of North America. RBC has indeed struggled due to the low Canadian dollar, where as the dollar has been a strong point for TD, considering a large portion of their earnings comes in the form of U.S. dollars. Considering the intense fears over Canada's housing market, and oil patch, TD would be a much safer choice, as it has the lowest exposure to the oil patch at less than 1%, and it also has a lower mortgage exposure than RBC, with 38% of its loan portfolio consisting of mortgages. Of these mortgages, TD also has less financial liability in the case of a housing meltdown, with 54% of its mortgages insured by the CMHC. TD is currently more expensive than RBC, with a 13 P/E compared to a 11.6 P/E for these reasons. Simply put, if you're bullish on Canada, and the oil patch, then RBC will give you better returns because of its exposure, however, with higher potential returns comes higher risk, as RBC has some of the highest exposure to housing and oil of the big five Canadian banks. If you want safety, then TD would be a better bet, and it will also rise along with the Canadian economy.
Valuation and Conclusion
RBC currently pays a very bountiful dividend yield of 4.22%, which is higher than its five year historical average dividend yield of 3.8%. The company raised its dividend by 8% last year, while Canada was in a full blown recession. There is no doubt that Canada will raise its dividend again this year, and for many years to come. The P/E, P/B and P/CF are also the lowest they've been in many years because the fears over Canada, the housing market, and oil prices have been overblown. Going forward, I expect the Canadian economy, and oil prices to rebound, and RBC is a fantastic way to play this trend, as there is a fair margin of safety considering its huge discount to intrinsic value. More volatility can be expected in the short term, and if RBC continues to drop, I'd recommend scooping up shares on any weakness.
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.