 Lowering Our Valuation Slightly for Bank of Nova Scotia Following Earnings, Shares Still Cheap

Equity Analyst

Michael Miller

Strategist

Eric Compton

Bank of Nova Scotia is the third-largest Canadian-based bank by assets and one of six Canadian banks that collectively hold almost 90% of the nation's banking deposits. It is known as Canada’s most international bank as it derives a little over half of its revenue from Canada, over 40% from international operations (primarily Latin America, namely Mexico, Peru, and Chile), and a single-digit percentage from the United States. Its domestic operations are more concentrated in mortgages and auto lending, with leading market share in autos. The bank has been expanding its domestic wealth operations significantly with its acquisitions of MD Financial and Jarislowsky Fraser, making it the third-largest active manager in Canada. The bank has been reworking its Latin America footprint, making acquisitions in markets it likes (Chile, Colombia) while reducing exposure to businesses and geographies that are less favorable as it attempts to consolidate better share within the area. The international exposure gives the bank the potential for higher growth and return opportunities compared with peers, but it also exposes the bank to more risks, as we've seen during the pandemic. While theoretically beneficial, the bank's international exposure has tended to be more of a headwind than tailwind.

After numerous acquisitions, we think the bank has made substantial progress on rationalizing its many back-end systems and improving efficiency bankwide, although much work remains. The bank's original goal was to have an efficiency ratio of 50% by the end of 2021; however, this was delayed given the less positive economic backdrop caused by COVID-19, and we forecast this goal will be delayed indefinitely for now. Further, new CEO Scott Thomson has begun to hint at what direction the bank will take under his leadership, and it appears that it will be a multiyear lift to improve performance.

As investment needs remain high and competition from peers also does not abate, we expect that expansion of the bank's returns on tangible equity will be limited for the time being. Increasing credit costs are also likely to pressure earnings for the time being.

Business Strategy & Outlook

We believe Bank of Nova Scotia is worthy of a Narrow Morningstar Economic Moat Rating. Although it has some of the best historical total bank operating efficiency, moaty nonbank businesses, and the ability to primarily operate in the favorable Canadian banking environment as its third-largest bank, we assign it a narrow moat rating instead of wide. The bank has significant, but not leading, market share in its domestic operations, and it has the lowest proportional exposure to Canada, at roughly 50% of revenue. Additionally, the bank's non-Canadian exposure is concentrated in Latin America, where we calculate the international segment has often struggled to earn returns on equity much above above the 11% average cost of equity we assign to that segment.

We argue that banks derive moats primarily from two sources: cost advantage and customer switching costs. We see a tightly regulated, oligopolistic market structure limiting excess competition within the Canadian system, therefore stabilizing product pricing and giving customers less incentive to switch banks. We see cost advantages stemming from three factors: a low-cost deposit base, excellent operating efficiency, and conservative underwriting; regulatory costs are also a factor we must consider. We view the Canadian banking environment as offering systemic cost advantages for the banks in its domain. These advantages manifest themselves in the form of lower operating costs, lower credit costs, lower regulatory costs, and lower absolute levels and better diversification of risk, all of which allow the banks to achieve greater risk-adjusted returns.

Bank of Nova Scotia has built up substantial market share within its Canadian retail operations and with large commercial clients. While the bank has number-one share within the fairly attractive auto and dealer floor lending space, the bank is usually not the number-one or number-two player for most products. The Canadian segment does earn returns on equity well in excess of the 9% cost of equity we assign to Canadian banking operations.

While its Canadian operations are strong, Scotiabank has the least proportional exposure to Canada among the Big Six banks, as nearly 50% of operations are outside Canada, primarily in Latin America. We believe these operations warrant a higher cost of equity of 11%, and at this point the bank earns roughly 14%-16% returns on equity in this segment. While we like the bank’s international exposure to higher-return and higher-growth markets, it tends to not be the dominant player in most of these markets, although its scale is improving. In these regions, the largest players with the most scale tend to earn the best returns and be the moatiest (such as Banco de Chile in Chile, Bancomer in Mexico, and Santander in multiple locations). 

Bank of Nova Scotia has built a decent-size wholesale banking and capital markets group. Based on deal credit, it tends to be a top 10 player within Canadian offerings, and it does a fair amount of business internationally. Also, while not historically a dominant asset manager among the Canadian banks, a series of acquisitions have improved the bank's standing here. Scotiabank is one of the larger asset managers among the banks and it should be seeing decent fee income from this segment. This gives the bank exposure to this higher-margin fee-based business that we don’t think will change in the near term as the banks still have the dominant branch and distribution networks.

We believe the Canadian banking environment offers systemic cost advantages that lead to returns above the cost of capital, allowing the main banks operating under its jurisdiction to possess moats. 

Barriers to entry are very high for the Canadian banking system. Existing regulations prevent foreign competition, as non-Canadian residents may not own more than 25% of the shares of a bank unless approved by the government, preventing foreign takeover. Foreign banks can operate in Canada only under certain restrictions, preventing significant direct foreign competition. The federal government also controls domestic competition, as Canada’s banking system historically developed to favor a few large banks controlling the majority of the domestic market, and this is actively enforced through the handling of chartering by the federal government exclusively. Additionally, the rejection of merger proposals in 1998 between Royal Bank of Canada and BMO, and between Toronto Dominion and Canadian Imperial Bank of Commerce, created a precedent where no further consolidation between the main Canadian banks will be accepted by the regulators. 

Having larger banks helps to spread out fixed costs across a larger operating base, increasing operating efficiency, as the four largest Canadian banks are all bigger than the largest U.S. regional bank. The Canadian banks arguably have some of the most powerful distribution networks within Canada because their branch networks are spread out through all of Canada. This offers cost advantages via lower customer acquisition costs. In addition, the banks are involved in nearly every major financial product, including asset management, wealth management, insurance, investment banking, and a variety of other consumer and commercial banking products and services. On a bigger scale, powerful distribution networks, a multitude of products, and diversification of business lines lead to economies of scope in addition to those already achieved.

We believe a more protective and efficient regulatory system also leads to cost advantages, primarily through risk reduction. Less fragmented and well-integrated banking systems like the Canadian system have tended to be more stable over time, reducing risk. Also, the Canadian regulators must only primarily monitor and develop relationships with the Big Six Canadian banks, which is much easier than trying to monitor the thousands of banks that exist in the U.S., for example. This leads to more collaboration and cooperation between regulators and banks as well as greater institutional memory and more coordinated and easily implemented responses if strains begin to appear in the system. Regulators also help to control pricing in the market at times, such as on mortgage products, helping to reduce the potential for pricing wars to gain market share at the expense of underwriting standards. In many ways, Canadian regulation makes it more difficult for banks to issue bad credit, including mandatory insurance and standards on riskier mortgage loans, not having a GSE like government subsidized mortgage securitization market, and forcing banks to hold more of the risk on their own balance sheets. These factors help contribute to better absolute risk reduction in the system as well as regulatory economies of scale.

The Canadian banks are also more geographically diversified on average than, for example, the majority of U.S. regional banks that often have concentrations within individual states or local economies. This diversifies credit risk, lowering the overall risk for each individual bank. Canada’s system of higher taxes, more social safety nets, and undoubtedly other complex factors have also led to a more robust and stable middle class that contributes to economic and political stability, further reducing systemic risk.

Combine all of these factors, along with explicit government subsidies on deposit insurance and mortgage insurance as well as the implicit subsidy of being too big to fail domestically (all Big Six Canadian banks are labeled as DSIBs), and we believe an environment exists where excess returns for banks are almost certain to exist in Canada.

Narrow

Economic Moat

Bank of Nova Scotia

SoctiaMocatta, is the precious metal and base metal banking division of The Bank of Nova Scotia. ScotiaMocatta is the oldest bullion dealer in the world, is one of the 10 market-making members of the London Bullion Market Association. Additionally it is one of five banks to participate in the London gold fixing. It has a history of 340 years, and is the only original member of the London Gold and Silver fixes to maintain its seats on both respectively.

SoctiaMocatta

Tangerine Bank, is a Canadian direct bank and a subsidiary of Scotiabank. It offers no-fee chequing and savings accounts, Guaranteed Investment Certificates, mortgages, and mutual funds. Many savings and investment products are eligible for registration under a Tax-Free Savings Account, Registered Retirement Savings Plan, or Registered Retirement Income Fund. Founded by ING Group in 1997 as ING Direct Canada, the bank was acquired by Scotiabank in 2012.

Tangerine Bank

The Bank of Nova Scotia engages in the provision of financial products and services including personal, commercial, corporate, and investment banking. It operates through the following segments: Canadian Banking, International Banking, Global Wealth Management, Global Banking and Markets, and Other. The Other segment includes group treasury and smaller operating segments. The company was founded on March 30, 1832 and is headquartered in Toronto, Canada.

Earnings data Q3 2020

Earnings data Q4 2020

Earnings data Q1 2021

Earnings data Q2 2021

Earnings data Q3 2021

Earnings data Q4 2021

Earnings data Q1 2022

Earnings data Q2 2022

Earnings data Q3 2022

Earnings data Q4 2022

Earnings data Q1 2023

Earnings data Q2 2023

Earnings data Q3 2023

Earnings data Q4 2023

Earnings data Q1 2024

Earnings data Q2 2024

Revenue

Cost of revenue

Gross profit

Operating expenses

SG&A

Other

Operating income

EBITDA

Net income

Earnings per share

Total assets

Current assets

Cash & equivalents

Receivables

Inventory

Non-current assets

Net PPE

Intangibles

Total liabilities

Current liabilities

Short term debt

Income tax payable

Non-current liabilities

Long-term debt

Total equity

Stockholders equity

Minority interest

Total liabilities & equity

Total debt

Net debt

Book value per share

Cash from operations

Funds from operations

Change in working capital

Cash from investing

Capital expenditure

Purchase/sale of investments

Purchase/sale of business

Other sources

Cash from financing

Change in stock

Change in debt

Cash dividends paid

Cash from other sources

Net change in cash

Free cash flow

Mitsubishi UFJ Financial

Banco Santander

Selecting stocks with compelling Shiller price-earnings ratios enhances the likelihood of identifying value opportunities, in my opinion. Thus, investors could be interested in the following stocks, as their Shiller price-earnings ratios are standing below the S&P 500 Index's historical average of 16.84 as of this writing.

A Trio of Low Shiller Price-Earnings Ratio Bank Stocks

Bank of America

JPMorgan Chase & Co

Coca-Cola

AT&T

AT&T 5.35 % Notes 2017-01.11.66 Global

The 4% rule for retirees is 25 years old; the market today is quite different.

Retirement: Get More Bang For Your Buck With High Yields

Canadian Imperial Bank of Commerce

Toronto-Dominion Bank

Don't just focus on the big-name U.S. financial institutions -- consider these great Canadian bank stocks for their portfolios. The post 3 Canadian Banks to Buy for Higher Dividends appeared first on InvestorPlace.

3 Canadian Banks to Buy for Higher Dividends

Financials are one of the few areas with some upside still left in the current market. Though massive reversal has occurred in most stocks, BNS still has room to run.

Scotiabank - Let's Clarify The 15% CAGR Upside

BNP Paribas SA

BNPQY vs. BNS: Which Stock Is the Better Value Option?

BNPQY or BNS: Which Is the Better Value Stock Right Now?

Fall in expenses, higher loan balance and drastic plunge in provisions support Scotia Bank's (BNS) fiscal Q2 earnings.

Scotia Bank (BNS) Q2 Earnings Increase Y/Y as Provisions Fall

The Bank of Nova Scotia (BNS) CEO Brian Porter on Q2 2021 Results - Earnings Call Transcript

TORONTO (Reuters) -Bank of Nova Scotia (Scotiabank) beat analysts' estimates for second-quarter profit on Tuesday, driven by fewer-than-expected provisions to cover loan losses, although that impact was somewhat offset by a surprise decline in earnings in its global banking and markets division.

Bank of Nova Scotia profit beats estimates on provisions, capital markets earnings slip

Bank of Nova Scotia (BNS) doesn't possess the right combination of the two key ingredients for a likely earnings beat in its upcoming report. Get prepared with the key expectations.

Bank of Nova Scotia (BNS) Earnings Expected to Grow: Should You Buy?

Bank of Nova Scotia (BNS) has an impressive earnings surprise history and currently possesses the right combination of the two key ingredients for a likely beat in its next quarterly report.

Why Bank of Nova Scotia (BNS) is Poised to Beat Earnings Estimates Again

TORONTO, May 13, 2021 /PRNewswire/ - Scotiabank today announced it will offer coverage for enhanced gender affirmation procedures for eligible employees and their dependents in Canada and the United States. Effective June 1, 2021, the addition of gender affirmation benefits to the Canadian and US plans will help fill the gaps in coverage to better support trans people on their own personal gender affirmation journey.

Scotiabank adds gender affirmation coverage to benefits for employees in Canada and U.S.

MEXICO CITY--(BUSINESS WIRE)--Scotiabank Mexico launched a MXN-denominated structured note linked to IndexAmericas, a corporate sustainability index developed by the Inter-American Development Bank (IDB). The groundbreaking index, developed by the IDB and structured and commercialized by BNP Paribas, includes 50 US-listed companies with strong commitments to sustainable development and environmental, social, and governance (ESG) issues, as well as a sizeable footprint in Latin America and the C

Scotiabank Launches Innovative ESG Investment Product Linked to the Inter-American Development Bank's IndexAmericas and jointly structured in partnership with BNP Paribas

The Bank of Nova Scotia (BNS) CEO Brian Porter Hosts Annual General Meeting (Transcript)

Bank of Montreal

China Telecom

Repsol SA

Triton International

With plenty of stocks to choose from, it seems like a good idea to go for those that have strong growth potential that also pay regular dividends.

6 Cheap Stocks Offering Growth & Income

Algonquin Power & Utilities

Brookfield Asset Management

Brookfield Infrastructure Partners L.P.

Canadian National Railway Company

Canadian Natural Resources

Enbridge

Franco-Nevada C

Fortis

Magna International

Pembina Pipeline

Ritchie Bros. Auctioneers

Royal Bank of Canada

Thomson Reuters

TC Energy

TELUS

Waste Connections

These 20 Canadian Dividend Aristocrats trade on either the NYSE or Nasdaq, and have increased their dividends annually for at least seven years.

The 20 Best Canadian Dividend Stocks for U.S. Investors

The Bank of Nova Scotia (BNS) Presents at NBF 19th Annual Financial Services Conference (Transcript)

Canadian stocks tend to trade for lower valuations than their U.S. counterparts, and many also have a higher dividend yield. The post 3 Canadian Stocks for Value and Income appeared first on InvestorPlace.

3 Canadian Stocks for Value and Income

Bank of Nova Scotia (BNS) has seen solid earnings estimate revision activity over the past month, and belongs to a strong industry as well.

Why Bank of Nova Scotia (BNS) Stock Might be a Great Pick

The Bank of Nova Scotia (BNS) Management Presents at RBC Capital Markets Global Financial Institutions Conference (Transcript)

Does Bank of Nova Scotia (BNS) have what it takes to be a top stock pick for momentum investors? Let's find out.

Here's Why Momentum Investors Will Love Bank of Nova Scotia (BNS)

Banco Santander-Chile

BNS vs. BSAC: Which Stock Is the Better Value Option?

BNS or BSAC: Which Is the Better Value Stock Right Now?

Bank of Nova Scotia (BNS) has been upgraded to a Zacks Rank #2 (Buy), reflecting growing optimism about the company's earnings prospects. This might drive the stock higher in the near term.

Bank of Nova Scotia (BNS) Upgraded to Buy: Here's What You Should Know

Scotia Bank (BNS) records a decline in revenues and lower expenses in the first quarter of fiscal 2021 (ended Jan 31).

Scotia Bank (BNS) Q1 Earnings Improve Y/Y, Provisions Decline

The Bank of Nova Scotia's (BNS) CEO Brian Porter on Q1 2021 Results - Earnings Call Transcript

Shares of Bank of Nova Scotia (NYSE:BNS) were flat in pre-market trading after the company reported Q1 results. Quarterly Results Earnings per share increased 2.13% year over year to $1.44, which beat the estimate of $1.32.

Bank of Nova Scotia: Q1 Earnings Insights

News for Bank of Nova Scotia Stock (BNS)