Bank Of Nova Scotia: Not Business As Usual, But Doing Very Well (NYSE:BNS)

Via SeekingAlpha.com

The financial sector got hit very hard with the coronavirus crisis following record low interest rates on the one hand and record high unemployment numbers on the other hand.

As a result, even the largest North American banks are still boasting attractive yields, and with all of them having reported on the most recent quarter, now is a good time to shine a light on them and discuss the current investment case.

Banks are a large part of my portfolio, and while that part has been almost hit as hard as the energy sector, I consider the dividends much safer. Following bullish comments from JPMorgan Chase (NYSE:JPM) CEO Jamie Dimon and continuous reopening in the U.S. and Canada, investors finally seemed to have caught attention to these bargains and powered the sector much higher this week.

Despite the sharp rebound, these stocks continue to provide a great opportunity for safety and growth.

The Bank of Nova Scotia (NYSE:BNS) currently appears very attractive, trading above a 6.3% yield having rallied from an above 7% yield within just two days. Still, the stock is trading significantly above its four-year average yield and provides a great income opportunity for long-term investors.

Source: The Journal Pioneer

What is going on at Bank of Nova Scotia?

The Bank of Nova Scotia, as part of Canada’s illustrious Big Five (Toronto-Dominion Bank (NYSE:TD), Canadian Imperial Bank of Commerce (NYSE:CM), Royal Bank of Canada (NYSE:RY) and Bank of Montreal (NYSE:BMO)), has a history of uninterrupted dividend payments dating back to the year 1833.

It currently trades at a P/E of 10 and a yield above 6.4%. As other financials, the stock sold off heavily in mid- to late-March before rebounding and staying in a price corridor. Following its earnings release, the stock broke out of that corridor, but is still down 25% YTD, making it the second worst performer among the Big Five

ChartData by YCharts

The latest results from its Q2 2020 report were better than expected, beating estimates on the top and bottom line and featuring a surprising 2.1% Y/Y revenue growth. As the quarter ended April 30, 2020, it gives us a much better overview about how COVID-19 is impacting the bank compared to its U.S. peers which only reported as of March 31, 2020.

Naturally, the bank recorded significantly lower earnings across its core segments following high loan loss provisions (PCLs) and potential litigation provisions. The table summarizes the development of adjusted net income per segment:

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Business segment

Adjusted net income

Q/Q % Y/Y % PCL added
Canadian Banking C$481M -47% -42% C$420M
International Banking C$197M -68% -73% C$516M
Global Wealth Management C$314M -1% +3% C$2M
Global Banking and Markets C$523M +16% +25% C$137M

Source: Earnings Release

Three things stand out for me here:

  1. No business segment recorded a loss on an adjusted net income basis.
  2. International Banking is much heavier impacted by loan loss provision building which is the result of the heavy impact of the pandemic in South and Latin American countries.
  3. PCLs added during the quarter of C$1.1B are almost as high as total adjusted net income of $1.37B.

Bank of Nova Scotia’s COVID-19 response

As an investor, it is very reassuring to see if management is responding well to the crisis and also supporting those which are not in a position to help themselves. As such, the bank supported its customers by lowering interest rates and fee waivers and providing liquidity and credit to business customers, its employees by having them work remotely and adding health and safety measures and its communities by helping local efforts to manage through COVID-19 and beyond.

The COVID-19 business impact of these actions and the overall pandemic can be seen along five dimensions: capital & liquidity, credit, revenue, expenses and digital.

COVID-19 Business Impact

Source: Bank of Nova Scotia Q2/2020 Earnings Slides

The bank also provided a very helpful overview of the policy response in the various core markets it is operating in. What stands out is obviously the massive discrepancy between fiscal and financial measures in % of GDP in U.S., Canada and Peru vs. poorer South and Latin American countries like Mexico, Chile and Colombia.

COVID-19

Source: Bank of Nova Scotia Q2/2020 Earnings Slides

As a result, the bank’s Canadian banking segment fared much better than its International banking segment, and this trend is very likely to continue over subsequent quarters, as simply not every government can come up with the massive federal stimulus measures of the “rich” countries.

Source: Investor Presentation – International Banking: Loans and Provisions

Given that in “normal” times, the International Banking segment is a bit more than half the size of the Canadian Banking segment, the poor performance can significantly impact earnings even as the recovery is unfolding. Long-term though the bank’s diversification in growing markets remains attractive.

Critically, these countries have the fiscal capacity and the institutional strength to respond quickly and effectively. Over the long-term, their resilience, young populations and the increasing importance of diversified supply chains will prove to be beneficial for their future economic growth. – Source: Bank of Nova Scotia Q2/2020 Earnings Call

Obviously, the major impact on adjusted net income the pandemic unleashes is via strong provision building for credit losses. Hovering at 50bps between Q2/2019 and Q1/2020, the PCL ratio for the entire bank has now more than doubled to 119bps led by 278bps in International Banking and 77bps in Canadian Banking.

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The major drivers are performing PCLs which increased by roughly $1B throughout the quarter driven by unfavorable macroeconomic outlook due to COVID-19 as well as challenging market conditions in oil & gas. Overall though the exposure of the bank’s loans to COVID-19 is rather limited.

We are also highly diversified by product, by sector and by geography. Our exposure to sectors most impacted by COVID-19 is limited at 4.7% of total loans reflecting substantial de-risking efforts in prior years – Source: Bank of Nova Scotia Q2/2020 Earnings Call

By sector, it breaks down as follows: energy (1.7%), real estate – office and retail (1.5%), hospitality & leisure (1.0%), transportation (0.5%).

Source: Bank of Nova Scotia Q2/2020 Earnings Slides

What’s in store for dividend investors?

It is truly important to focus on the long-term picture, and in that regard, placing your money in a bank that has one of the longest dividend payment streaks ever is a solid decision. Over the past 45 years, strong earnings growth has led to dividend increases in 43 years. Its 10-year EPS growth stands at 9%, while dividends increased at a 6% clip in the same time. Even with the first “COVID-19 quarter” in the bank, the dividend remains covered albeit the payout ratio unsurprisingly jumped to 86% on a quarterly basis.

Dividend

Source: Investor Presentation Q2/2020

The bank is targeting to grow EPS at 7%+ pace over the medium term (once the COVID-19 impact is being lapped), which should also translate into similar dividend growth going forward, with a target dividend payout ratio between 40% and 50%.

Right now, the bank’s liquidity position remains strong with a liquidity coverage ratio of 132% even though its CET1 ratio fell to 10.9% from 11.4% sequentially.

The Canadian banks are a solid and sizable component of my dividend portfolio (>4% of dividend portfolio weight), as their rather boring business is producing steadily rising and reliable dividend income. Over the long term, I intend to further add to my existing holdings, as when it comes to long-term dividend growth, Canada’s banks have one of the most impeccable track records.

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And you should not fall victim to the bias that Canada’s banks are only about Canada. It is true that for the Bank of Nova Scotia, the majority of earnings is still generated in Canada, but its international segment is growing fast with several acquisitions and investments. All this should help build a better bank, for customers drive continued growth for the bank and its shareholders.

The bank has recently declared its next dividend with the stock going ex-dividend on July 6 with dividend payment set for July 29. The snapshots below are taken from my newly and free-for-all released Dividend Calendar (make sure to follow instructions in the video) and show the next expected ex-dividend dates and payouts for the Bank of Nova Scotia.

(Source: My Dividend Calendar)

Investor takeaway

Investors have likely missed the bottom in the bank’s stock, but even after a sharp rebound in the low 40s, the stock is very attractive for long-term investors.

A sharp drop in economic activity in 1H20 is expected to lead to a strong rebound in 2H20 if the virus remains contained and should have only limited lasting impact on the bank’s core Canadian markets.

The dividend remains covered, and with a yield north of 6%, it is one of the best times to buy the stock for long-term dividend income. It is unclear if the bank can maintain its dividend growth record this year keeping the dividend flat so far this year, but I am very confident that the dividend won’t be cut if the promising recovery signs we are seeing continue. If the strong rebound in the second half of the year unfolds, I fully expect at least a modest (2-3%) dividend raise later in the year as the dividend train pierces through challenging economic times.

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Disclosure: I am/we are long BNS, TD, CM, RY, JPM. 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: I am not offering financial advice but only my personal opinion. Investors may take further aspects and their own due diligence into consideration before making a decision.