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Royal Bank: Growth Expected To Moderate In 2019 – Royal Bank of Canada (NYSE:RY)

Investment Thesis

Royal Bank of Canada (RY) is one of the 2 largest banks in Canada in phrases of belongings. Although the financial institution delivered wonderful This fall 2018 earnings, its enterprise development is anticipated to average in 2019 because of (1) unsure macroeconomic situations and (2) slowdown in Canadian housing market. The firm presently pays a 4%-yielding dividend and its shares are presently barely undervalued. However, we predict buyers might wish to wait on the sidelines because of the present unsure macroeconomic situation.

RY knowledge by YCharts

Impressive This fall 2018

In its This fall Fiscal 2018, Royal Bank posted stable high and backside traces development. The firm noticed its income elevated by 7% 12 months over 12 months (internet of insurance coverage truthful worth change). Thanks to its effort to regulate non-curiosity expense, its internet revenue elevated by 15% 12 months over 12 months to C$3.25 billion in This fall 2018. We like the truth that Royal Bank continues to enhance its return on widespread fairness. As could be seen from the desk under, its ROE improved to 17.6%. This was an enchancment of 100 foundation factors 12 months over 12 months.

Royal Bank

Source: Q4 2018 Investor Presentation

As could be seen from the chart above, Royal Bank’s internet revenue elevated by double digit in virtually all enterprise segments besides its Investor & Treasury Services section. Its internet revenue in I&TS section was offset by the financial institution’s know-how investments.

Royal Bank continues to ship wonderful effectivity ratio. In This fall 2018, its effectivity ratio of 43.8% in its Canadian Banking division was 90 foundation factors decrease than This fall 2017. This is the third consecutive quarters of effectivity ratio enchancment (12 months over 12 months).

Royal Bank

Royal Bank’s Efficiency Ratio in its Canadian division (Source: Q4 2018 Investor Presentation)

Reasons why we predict development might average in 2019

Despite a powerful This fall 2018, we predict Royal Bank’s development in 2019 will doubtless average for the next causes:

Fed and BoC have gotten extra dovish

Since mid-2017, Canada has raised its benchmark rate of interest 5 occasions. These 5 price hikes elevated Canada’s benchmark rate of interest to 1.75%. As could be seen from the chart under, Royal Bank’s internet curiosity margin in its Canadian Banking division additionally progressively elevated from 2.63% in Q3 2017 to 2.77% in This fall 2018. This is an enchancment of 14 foundation factors in two years.

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NIM in Canadian Banking (Source: Q4 2018 Investor Presentation)

In Royal Bank’s U.S. Wealth Management division, NIM has elevated considerably from 2.96% in This fall 2017 to 3.41% in This fall 2018 due to Fed’s price hikes prior to now two years.

NIM and NII in Royal Bank

NIM in Royal Bank’s U.S. Wealth Management (Source: Q4 2018 Investor Presentation)

Looking ahead, we consider will probably be a problem for Royal Bank to increase its NIM considerably on each side of the border. This is as a result of Bank of Canada has just lately switched from a extra hawkish tone again in October to a way more dovish tone on Dec. 5, 2018. In the assertion that BoC released, it says:

“Signs are emerging that trade conflicts are weighing more heavily on global demand… the global economic expansion is moderating.”

Many analysts believe that the message is sort of clear: Rate hikes are off the desk for now. In the U.S., Federal Reserve has just lately raised its rate of interest on Dec. 19, 2019. However, fewer price hikes are expected in 2019 than 2018.

Since the tempo of price hikes in 2019 will doubtless be slower than 2018, it might be pure to anticipate solely modest growth in NIM. Even although administration expects 5~10bps of quarterly NIM growth in 2019 in its U.S. banking, we predict the precise end result could also be in the direction of the low finish of its steerage.

Slowdown in mortgage development

The introduction of B-20 Guideline in Canada efficient on January 1, 2018 has resulted in a mortgage development slowdown and decrease housing market actions. About 6 months in the past, we held the view that there have been indicators of stabilization. However, as time progresses, we’re starting to see extra indicators of additional slowdown. As could be seen from the chart under, Royal Bank’s mortgage portfolio in This fall 2018 of C$246 billion solely grew by 4.6% 12 months over 12 months. This was decrease than Q3’s 5.9% development price. While the expansion price is definitely disappointing, we famous that it’s nonetheless a lot better than Bank of Montreal’s (BMO) 1.2% and CIBC’s (CM) 0.5% development charges 12 months over 12 months.

Royal Bank

Source: Created by writer; Company Reports

While the introduction of B-20 Guideline was one of the primary contributors to the deceleration in mortgage stability development price, we have to additionally perceive that Canadian family debt can be fairly elevated. As the chart under exhibits, its debt-to-revenue ratio is anticipated to achieve 173% by the tip of 2018, the very best we’ve got seen in lots of a long time. We consider the elevated debt degree coupled with 5-interest price hikes since mid-2017 will proceed to restrict future mortgage development in 2019. This implies that will probably be difficult for Royal Bank to develop its curiosity revenue at a quick price.

Household debt-to-income ratio in Canada

Source: RBC Economics

Debt Service Ratio in Canada

Source: RBC Economics

Valuation

Share value of Royal Bank has declined by about 10% prior to now 3 months. As a end result, Royal Bank presently trades at a value to 2018 EPS ratio of 11.3x. This is barely under its 5-year common P/E ratio of 12.6x. However, its P/E ratio is barely above the typical of 10.7x of its Canadian friends. Royal Bank’s ahead P/E ratio of 10.4x can be above the typical of 9.6x of its Canadian friends. We consider Royal Bank deserves larger valuation than its Canadian friends due to its wonderful working effectivity ratio and its bigger scale. Therefore, we predict its present valuation continues to be barely undervalued.

Valuation Analysis

RY knowledge by YCharts

An enticing 4%-yielding dividend

Royal Bank presently pays a quarterly dividend of C$0.98 per share. This is equal to a dividend yield of 4%. Royal Bank has constantly raised its dividend since 2011. As could be seen from the chart under, its dividend yield of 4% is in the direction of the excessive finish of its yield vary since 2010.

Dividend Analysis

RY knowledge by YCharts

Risks and Challenges

Royal Bank faces macroeconomic dangers. In an financial recession, the potential for client defaults might rise sharply relying on the severity of the recession. In addition, if there’s a housing market crash, the financial institution’s mortgage portfolio could also be negatively impacted.

We consider buyers also needs to be mindful of administration’s latest touch upon macroeconomic dangers. In the conference name, Royal Bank’s Chief Risk Officer stated,

Despite the optimistic baseline outlook, we do see elevated exterior dangers. Most notably, world commerce tensions, rising rates of interest, and weakening oil costs present potential draw back threat for our present macroeconomic outlook. As all the time, we’re sustaining a prudent threat administration method and intently monitoring these developments.”

Investor Takeaway

Royal Bank is a nicely-managed firm with good working effectivity. Although Royal Bank’s shares are presently barely undervalued, we predict buyers ought to be cautious particularly within the present unsure macroeconomic surroundings. Hence, conservative buyers might wish to wait on the sidelines.

Note: This will not be monetary recommendation and that each one monetary investments carry dangers. Investors are anticipated to hunt monetary recommendation from professionals earlier than making any funding.

Disclosure: I’m/we’re lengthy TD, CM. I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (aside from from Seeking Alpha). I’ve no enterprise relationship with any firm whose stock is talked about on this article.



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