My Least Favorite Canadian Bank

| About: Canadian Imperial (CM)

Summary

The Canadian banks have generally presented an attractive opportunity for the individual investor.

CIBC is the smallest of the Big 5, and has a greater operational concentration in Canada than any of it's competitors.

While their high dividend yield may be attractive for income-seeking investors, I do not believe the dividend will continue to grow unless investments in other markets are made.

Fortunately CIBC recently announced the purchase of PrivateBancorp, pushing their operations into the US.

This detailed analysis outlines why I prefer other banks over CIBC.

As a group, the Canadian banks generally present a safe investment opportunity with healthy dividend yields, encouraging growth prospects and a compelling value proposition.

However, just like any other group of stocks, the Canadian banks are capable of being ranked. This naturally means that one must take the last position.

In a previous post where I analyzed the fundamental characteristics of the Canadian banks, Canadian Imperial Bank of Commerce (NYSE:CM), or CIBC, ranked #3 out of 5. However, the analysis was inherently flawed because I weighed all metrics equally. This meant that less-important qualities like payout ratio where considered to be just as important as EPS growth. As well, the analysis was based on rank, so the best bank received a score of 1 and the worst bank received a score of 5, regardless of the magnitude of the outperformance.

So while CIBC ranked #3 in that analysis, they are objectively my least favorite Canadian bank. Here I will outline why.

Business Overview

Before diving into the specifics of this analysis, I find it's always helpful to start with a business overview.

CIBC is a diversified Canadian financial institution that divides their operations into three categories:

Retail and Business Banking provides personal and business clients across Canada with financial advice, products and services. We have a strong team of advisors and relationship managers in our banking centres or through remote channels such as mobile advisors, telephone, online or mobile banking. Retail and Business Banking is focused on being the number one Retail and Business Bank in Canada in client experience and profitable revenue growth. To deliver on our objectives, we are making banking easy, personalized, and flexible. This will support us in deepening client relationships, and acquiring and retaining clients.
Wealth Management provides integrated advice and investment solutions to meet the needs of institutional, retail and high net worth clients. Our asset management, retail brokerage and private wealth management businesses combine to create an integrated offer, delivered through more than 1,500 advisors across Canada and the U.S.
In Wealth Management our growth strategy is supported by three strategic priorities:
1. Enhance the client experience and strengthen relationships
2. Attract new clients
3. Pursue strategic growth opportunities
Capital Markets provides integrated credit and global markets products, investment banking advisory services and top-ranked research to corporate, government and institutional clients around the world. In November 2015, the name of this business unit was changed to Capital Markets from Wholesale Banking.
Our goal is to be the leading Capital Markets franchise in Canada, with global capabilities aligned to the needs of our clients. We are focused on developing deep client relationships and earning our clients' trust through unparalleled execution and innovation, and strong collaboration across CIBC.
- 2015 Annual Report

Now, onto the analysis.

Book Value - An Important Metric

In my eyes, the two most important historical metrics to consider before investing in any stock are earnings per share and book value per common share.

I'll start with book value, since it is my favorite proxy for intrinsic value. While most companies trade either at a premium to book value or a discount to book value based on their industry, these premiums tend to remain range-bound. This means movements in book value typically move in tandem with movements in stock price, at least over the long run.

So how has CIBC's book value changed over time?

Source: Publicly available financial statements (graph my own)

Generally speaking, CIBC's book value growth is strong when you compare it to the market as a whole. But like I said, the Canadian banks as a group are strong, so I need to compare CIBC to it's peers, not unrelated companies.

CIBC's book value growth from $25.17 in 2000 to $51.73 in 2015 represents a CAGR of 4.9%, which compared to 8.5% for TD (NYSE:TD) and 9.7% for RBC (NYSE:RY) seems rather paltry. I am also rather alarmed by the significant write-downs in book value that occurred in 2005 and 2008. While 2008 represents the financial crisis, I'm not sure what happened in 2005.

Earnings Growth

Next we'll consider the earnings growth of CIBC. I'll be comparing CIBC to it's entire peer group here.

Source: Publicly available financial statements (graph my own)

In recent history, CIBC has grown their earnings per share at a rate right around the middle of their peer group. Nothing exciting here, but not a negative for the stock either.

Dividend Yield and Growth

Right now, CIBC pays the highest yielding dividend of all the Canadian banks.

CIBC Pays a High Dividend Yield

Source: Google Finance

The high dividend yield relative to peers naturally makes me question the safety of the dividend. The next step is to look at the company's payout ratio. I was surprised given CIBC's high dividend yield that their payout ratio is not noticeably higher than their peers:

Source: Publicly available financial statements (graph my own)

And what about the growth of the dividend? In my opinion, corporate dividend growth policies are largely determined by the asset allocation decisions of the management teams. So as long as the guiding principles of management teams do not change, then corporations with strong histories of increasing dividends have high probabilities of doing so in the future. The following graphs, adapted from my earlier post about the Big 5 Banks, outlines CIBC's stance on dividend growth versus their peers.

Source: Publicly available financial statements (graph my own)

CIBC's recent dividend growth history has lagged behind the two banks that I consider to be industry leaders - TD and RBC.

Management Team

CIBC is led by Chief Executive Officer Victor G. Dodig, who assumed the role in September of 2014. Interestingly, this came at a time when other major banks were similarly making changes at the Chief Executive level. Bharat Masrani become TD's CEO on November 1, 2014; David McKay became RBC's CEO on August 1, 2014; and Brian J Porter became the CEO of the Bank of Nova Scotia on November 1, 2013. The only Big 5 CEO who was appointed outside of this 2-year window is BMO's William Downe, whose tenure began on March 1, 2007.

I believe that leadership starts at the top, and since Dodig is very new in his CEO role, he still has to prove his worth. I have also been unable to find exactly how long he's been with the company, which is troubling to me. In a complicated business like that of banking, it's best if the leadership team has been with the organization for a long time. You see this in TD's CEO, who has been with the company since 1987.

Growth Prospects

My biggest qualm about an investment in CIBC is the lack of future growth prospects.

Since the Canadian financial services industry is dominated by the major 5 banks, CIBC operates in what is essentially an oligopoly. This lack of competition means that it is more difficult for CIBC to increase market share without expanding into new markets. If they intend to stay as a Canada-only bank, they will only grow at the rate of Canada's GDP unless they can steal market share from the other four major players.

And therein lies the problem - CIBC is not effectively penetrating other markets, particularly when compared its competitors:

  • TD has effectively penetrated into the United States with the formation of TD Bank, America's Most Convenient Bank. 27% of TD's 2015 earnings came from their U.S. Retail segment, which is growing at a much faster pace than the Canadian Retail equivalent. This is very promising for future growth.
  • Scotiabank (NYSE:BNS) continues to be Canada's most international bank. According to their 2015 Annual Report, they held only 59% of their assets in Canada. The rest was divided between U.S. (15%), Pacific Alliance (9%), and Asia/Europe/Other International (17%).
  • According to their 2015 Annual Report, RBC generated just 63% of their revenue from Canada, with the remainder being split between the United States (19%) and International (18%) segments.
  • BMO (NYSE:BMO) has a significant US presence through BMO Harris Bank in the US Midwest. They also recently acquired Marshall & Ilsley, a Milwaukee-based financial services provider, in 2010 for $4.1 billion.

Compare these three competitors to CIBC - whose 2015 Annual Report only contains the word "geography" once. And you get the point.

Fortunately, CIBC is taking measure to improve their operational diversification.

In June, CIBC announced the $4.9 billion acquisition of PrivateBancorp, a Chicago-based bank that delivers retail, commercial, and wealth management services using the name The PrivateBank. This deal pushes US operations to 10% of total earnings for CIBC, and management has communicated that they want to increase this number to 25% within the next five to seven years.

Before the acquisition, CIBC was limited in their US operations to private wealth management through their subsidiary Atlantic Trust.

So while CIBC is currently overexposed to the Canadian markets, they are taking steps to diversify into the US. They aren't where I'd like to see them yet, but the progress is (slightly) encouraging.

The Bottom Line

As far as investments go, the Canadian banks are a fantastic peer group when compared to the rest of the stock market.

However, CIBC is not one of the strongest. Their high dividend yield does not overcome their lack of diversification outside of Canada or their less-than-promising growth prospects.

Stay tuned for more analysis on other stocks (Canadian and otherwise). If you found this article useful, please subscribe to my blog and follow me on Seeking Alpha.

Readers, what are your thoughts on the investment prospects of CIBC? If not CIBC, who is your favorite Canadian bank? Let me know in the comments section!

Disclosure: I am/we are long TD, RY.

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

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Tagged: , Money Center Banks, Canada
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