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Royal Bank Of Canada: Strong Business, But Further Downside Likely

Discount Fountain profile picture
Discount Fountain
4.44K Followers

Summary

  • Royal Bank of Canada saw a strong earnings season for Q1 2020 as a result of Capital Markets growth.
  • However, the market fallout from COVID-19 is likely to have a significantly negative impact on earnings going forward.
  • I remain long, but will not be adding more shares until the economic situation improves considerably.

Back in June of last year, I made the argument that while the Royal Bank of Canada (NYSE:RY) remained a fundamentally strong business, the bank had been overly dependent on US operations to sustain growth, and the economic situation in Canada itself remained on shaky ground with high household debt levels and uncertainty at the time regarding a renewed NAFTA trade deal.

That said, COVID-19 has clearly been a game-changer, with Royal Bank of Canada declining significantly as a result of the market fallout:

Source: investing.com

With social distancing measures in place across most of the world as well as outright lockdowns, demand for oil has plummeted. We see that while Canadian Crude Oil (CCX) had recovered from lows at the end of 2018, price has since plunged to 5.08 at the time of writing:

Source: investing.com

Given that oil forms a large part of Canada’s export market, the major financial institutions in Canada also have a sizable exposure to fluctuations in this commodity.

For instance, when taking a look at the bank’s PCL (provision for credit losses), we see that while the overall PCL fell heading into Q1 2020, PCL for capital markets did increase by $1 million from the previous quarter, which the bank cites as being a result of higher provisions for the Oil & Gas industry and Other Services.

With that being said, this increase is minuscule when compared to the bank’s overall PCL, and it is also noteworthy that Royal Bank of Canada has the lowest loan exposure to this sector of all the major Canadian banks.

Source: bnnbloomberg.ca

Moreover, while the market fallout from COVID-19 will invariably have an impact on the Royal Bank of Canada, Q1 2020 earnings results prior to this were actually quite encouraging.

Revenue was up by 9% YoY to $12.8 billion – fundamentally

This article was written by

Discount Fountain profile picture
4.44K Followers
I am an independent investor with an interest in analyzing stocks across the consumer, finance, telecommunication, and travel sectors. As a data scientist, I also have a great interest in using data tools to better understand a company's financial position.Some examples include:- Analysing total room revenue across brands for Hyatt Hotels using data visualisation: https://seekingalpha.com/article/4632039-hyatt-hotels-stock-hyatt-regency-and-china-revpar-growth-impressive- Building a Monte Carlo simulation in Python to analyze loss ratios for Zurich Insurance Group (ZURVY): https://seekingalpha.com/article/4605533-zurich-insurance-group-premium-growth-low-loss-ratio-encouraging- Calculating seasonality of customer lifetime value (LTV) for AT&T: https://seekingalpha.com/article/4634204-att-stock-growth-customer-lifetime-value-necessary-upsideDisclaimer: All of the author's articles are written on an "as is" basis and without warranty, with no guarantee of accuracy or completeness. They represent the author's opinion only and in no way constitute professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions. The author disclaims all liability for any actions taken based on the information contained in any articles published.

Analyst’s Disclosure: I am/we are long RY. 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.

Additional disclosure: This article is written on an "as is" basis and without warranty. The content represents my opinion only and in no way constitutes professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (14)

n
When loan provision start to raise this is perfect time to add to your position in this high quality bank. Lookout 3-5 yrs when this moment in time is behind us your position in the bank will have increased as well the dividends being paid. Real investing
b
RY for the long term.

BTW, Is your username taken from Japanese? As in, second degree or second rank?
n
Bberkiev. That is correct. Rank within Goju Karate do. Long RY and will be for a longtime coming. Held shares for more 20 yrs and still buy on a regular basis. Creating wealth slowly and methodically
b
Oss, fellow karateka.
The discipline from karate has helped with investing.
u
Have held RY for well over 10 years. Tempted to buy more down here with that 5+% yield.

Retired dividend-growth investor
m
I am unclear as to the basis of your negative view on Capital Markets income levels. Bond trading and debt placements seem to be rising across the markets as liquidity becomes central to survival. All of this action is positive to this segment.

Large PCL provisions relating to changes in market assumptions will certainly impact Retail Banking similar to US Banks.
Discount Fountain profile picture
That's true. Investors will still be willing to invest in bonds even if the payout is negative in exchange for security (e.g. German 10-year yields stand at -0.50%). That said, my concern is that if stock market activity declines significantly then I would have thought this would have an impact on capital markets, even if the bond market remains buoyant.
Belaire profile picture
My biggest concern for RY is it's exposure to USO through RBCCM. It acts as the clearing house for that fund and loses in the fund are $700 million already. Judging by the constant re-jigging of USO you know somebody is concerned too. I am not entirely sure if those loses end up in RBCCM's lap or not. Will like RY much more once that clears up.
Thank you for the article.
j
Thanks for the article, in your opinion is the dividend safe?
Discount Fountain profile picture
Hard to say. There was been dividend growth for 3 years and the payout ratio is 50%, so the bank is reinvesting a significant amount of cash. That said, if the stock is not attracting interest from investors, then they may well choose to cut the dividend to conserve cash for the short to medium term.
Shepferg2 profile picture
I added RY because of the relatively high div and the fact that it is the least exposed to oil. Also opened TD, although I didn’t realize the oil exposure was quite so high! That said, RY has been more of a stalwart than a huge earner in my portfolio. If it takes a bid drop from here or they cut the div I will have to reassess. If neither happens, I will be very happy with the addition to my portfolio.
conkjc profile picture
If the stock is not generating interest from investors, I can't see how cutting the dividend would help that. If anything, cutting it would send a shock wave most likely leading to a further decline in share price. Most of the Canadian banks have been paying uninterrupted dividends since Reconstruction with the only declines coming from the variation in conversion rates between CAD and USD and other currencies. I see a dividend cut as very unlikely and if it would happen if would lead to further share price declines across the whole sector.
Anyone looking out 5 or more years would probably do well to pick up more shares now at reduced prices.
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