Whether or not the central banks of many of the world's developed nations acknowledge it or not, they will soon begin cutting interest rates. The reasons are plentiful but two stand out: the US economy will soon begin to trend lower and with it most of the rest of the G-7 nations.
Europe has already slowed, Japan is having one of its never-ending political upheavals, and China and India are attempting to slow their economies in the face of rising inflation.
Additionally, the recent cut in rates by the US Federal Reserve has spiked the US dollar lower against most of the other world currencies. This will give US companies a powerful competitive advantage in the global markets, and at the same time, make foreign exports to our nation more costly. Taken together, these forces will cause a string of interest rate cuts around the world, probably beginning with Canada.
In the picture I see forming, our Canadian neighbors may well come out looking very good for a period of time. They are a natural resource exporting nation, so their products will continue to be in demand, even if prices begin to stabilize.
Canada's banks are strong, with few of the subprime issues that will continue to nip at the heals of American banks, and finally, the country's Conservative government is finally beginning to deliver on some campaign promises. Importantly, as I said last time, Canada just cut corporate income taxes to near 30%, among the lowest in the developed world, and well under US corporate tax rates.
In running Canadian companies through our Dividend Valuation Model, I see many that are cheap. In the coming months, I will describe a few here.
The best valuation I see is Toronto Dominion Bank (see chart above). It is the second largest bank in Canada and has been making strategic acquisitions in the US. Its combination of a 2.8% dividend yield and low double-digit dividend increases over the past few years has made it a solid performer but has still left it significantly undervalued.
Our model says (I am showing TD in its local currency) that the stock may be as much as 15% undervalued, based on my estimate of next year's dividend growth.
Canada's natural resource oriented economy will insulate it from the economic slowdown that may hit most of the rest of the G-7 nations. Indeed, Canada and the US may be the only G-7 nations that will not experience any negative quarters of economic growth over the next six months to a year.
Monday, September 24, 2007
Oh Canada !
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9 comments:
I look forward to seeing your analysis on the Canadian Banks. I personally hold the Royal Bank and it is by far my strongest performer. A nice growing dividend and good stock price growth (even with the pull back in the past couple of months) has been nice to own.
Yes, TD Bank is highly rated. Some years ago they managed to pull off that rare event, a successful merger, when they bought Canada Trust. This catapulted them in size. I've played around a bit with spreadsheets, but I can't say I have the sort of model you have. But yes, I would feel comfortable adding TD to my portfolio (though I don't currently own it). There is nothing on the ground up here in Canada that would suggest TD is a bad investment (i.e. walking into their branches, there is nothing to suggest they are not competitive with the other Canadian banks).
One thing to watch with Canadian banks, is their growth strategy. Denied the chance to merge at home (though there are no 10% caps on deposits like the U.S.) Canadian banks are seeking to grow outside Canada. Some have tried to grow into the United States, but are finding the margins are less. Others are growing in Latin America or Asia, with more success.
Canada's economy is strong right now. Part of it is the policies of the Conservative government (though in a Minority government they have to agree to all sorts of silly spending by the socialists and separatists to allow them to stay in power). Still, Stephen Harper just might be the smartest man to ever be the Canadian Prime Minister, and with a Masters degree in Economics to boot! Canada continues to run a budget surplus, and continues to pay down our national debt. In fact the budget surpluses have been a bit of an embarrassment for governments (both Conservative and Liberal) because it looks like they can't forecast revenues properly. But this isn't such a bad thing, because any surpluses are automatically by law applied to the debt. On the other hand, growth in Canada is uneven. Alberta is doing great with soaring oil prices, while manufacturing in Ontario is getting hurt by the comparative fall in the U.S. dollar.
Thanks to our Canadian friends for their thoughts. Surplus, strong economy, cutting taxes, plenty of natural resources, good margins -- these are traits that generally spell success. Canada may be ready to shine economically, not just in North America, but in the world.
I will run the Dividend Valuation on Royal Bank of Canada next. It looked good, just not as cheap as TD.
I also own one of the major Canadian banks, (don't want to tout it), but it has more of an international flavour to its growth pattern.
I'd only quibble with one of your comments (perhaps a central one); I don't think David Dodge (Bank fo Canada chief) is going to lower interest rates.
Certainly, his recent comments suggest that he thinks they went too low even in Canada (and they never hit the lows they did in the US). He feels asset inflation is a problem that central bankers more or less ignored to their peril, with these problems just crawling out of the wood-work.
In any case, Canadian banks appear strong, well-capitalized, and perhaps readier for growth than they've been in three decades, if US opportunities arise through troubled bank sales.
Jay Walker
The Confused Capitalist
David Dodge speaks ...
http://www.reportonbusiness.com/
servlet/story/RTGAM.20070926.
wrdodge26/BNStory/robNews/home
Jay Walker
The Confused Capitalist
(Doesn't sound like he thinks lowering interest rates right now is a good idea).
Jay,
Thanks again for the comments on the Canadian economy.A rate cut in Canada is not central to the good news for Canadian stocks and economy that I had in mind. Having said this, I think it will be very difficult for Canada to avoid a cut if each successive reduction by US Fed drives the US dollar lower.
Toronto Dominion's purchase of Commerce Bank is the positive side of the dollar issue. American banks are about 20% cheaper in Canadia dollar terms than they were just a few months ago. My guess is that we will see more purchases by Canadian banks.
The question then becomes what do the Canadian Banks bring to the US market that is not already here.
From what I read, the Canadian Banks are very big on loyalty. Perhaps more on the order of the Wells Fargo model.
We have had a lot of Canadian experts comment here. Does anyone have an opinion of the potential for success of the Canadian Banking business models in the US?
As far as Canadian banks making it big there - I don't know. In the 1970s, the five big Canadian banks were typically among the top fifty or so world-wide (by assets). They timidly let many others pass them by, and it wasn't helped by the governments' desire not to let any of them merge.
Through much of the 1990s, our bank multiples were low, making US purchases expensive. The Bank of Montreal bought Harris Bank, but hasn't really been able to capitalize on that very profitable Chicagoland footprint. In my opinion, the BMO is probably the worst of the Canadian banks.
The others have played around the periphery at US expansion. Having said that, the fundamentals for a true drive into the US market are as good as ever.
Scotia Bank (BNS) has expanded around the Latino countries and Caribean basin, very patiently. I think they are probably the most intenationally flavoured of all the Canadian banks. They aren't splashy, but seem to be willing to buy into local banks slowly, gain trust, and keep expanding their footprint that way. (However, their domestic wealth management profile sucks)
They all have relatively cautious underwriting standards, which have kept them out of any real trouble, with a few notable exceptions from time to time. I guess the one thing is, is that every time they get a bloodied nose, they kind of retrench to a conservative business model.
CIBC (CM) at one time was moving into capital markets in a big way, but then they had their nose bloodied, and boom, it's back to basic retail banking.
Same with TD too, at one time with their telecom sector loans.
I'd say that perhaps your comments re: Wells Fargo are correct. They are trying to be "the one" to their best customers, and most of them have made major inroads, especially in the wealth management area.
Probably the Royal (RY) has the best model in this regard, and the largest head-start. It's perienally rated by analysts as one of the two best Canadian banks (the others rotating in and out of favour).
US expansion successful? If strong balance sheets, careful lending, and patience are important in the next 10 years, then I'd say yes. But I suggest that all are going to use the US weakness over the next 1-3 years to make significant purchases - now or never, baby.
Jay Walker
The Confused Capitalist
I agree with you on TD.TO stock.
Personally, I monitor the bank's stock prices on the TSX and currently, my favorites are TD.TO, BMO.TO, NA.TO, LB.TO and BNS.TO.
I am thinking of adding a few more to my watch list, do you have any suggestions?
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