EUR 850.00 For Business Accounts Only

Morningstar | One-Time Acquisition Charges Mar 3Q Results for Scotiabank; We're Waiting for Accretion in 2020

Narrow-moat Bank of Nova Scotia, or Scotiabank, reported okay fiscal third-quarter results. Results don’t change our long-term outlook for the bank, and we are maintaining our CAD 80 fair value estimate for Canadian shares and our fair value estimate for U.S. shares of $62. Earnings per share were down year over year, to CAD 1.55 from CAD 1.66. This was largely due to a number of one-time items related to the string of acquisitions the bank has been undertaking. Adjusted earnings per share were CAD 1.76, representing growth of nearly 5% year over year.

The adjusted return on equity came back down this quarter, to 14.5%. This is beginning to fall back in line with our near-term projections. Operating leverage is still positive year to date, coming in at 4.5%. With year-to-date diluted EPS growth now of 9%, the bank is still on track to meet the medium-term 7% EPS growth goal this year. Credit quality also remained pristine, particularly in Canada, as PCL and NCO ratios remained stable. Among peers, Scotiabank remains one of the least exposed to the Canadian real estate market. We like the expense control in Canadian Banking, where expenses were up just 1% year over year, however, unadjusted results don’t look great for International Banking. Loan growth is still strong internationally, and once one-time acquisition related items go away, results should improve here. Scotiabank remains the most internationally diversified of the big Canadian banks, giving it higher growth potential amid a slowing Canadian mortgage market as well as exposure to higher international economic and political risks.

We have mixed feelings about Scotiabank’s results and overall strategy. On one hand, we can appreciate the bank is making moves to bolster its share in emerging markets, a unique strategy when compared with its Canadian peers. This may really pay off if Canada begins to suffer major growth and credit issues. We can also appreciate the bank is making moves to bolster its share within the asset and wealth management sector, a good business to be involved in. However, we note that these deals don’t seem to be coming at bargain prices. While details are limited, earnings per share accretion is usually not occurring for 2-3 years for the wealth manager deals, and this is excluding integration and amortization costs.

Furthermore, the latest deal for MD Financial cost the bank 5.3% of AUM, and the price to estimated after tax earnings by year three is still 17.2 times. The emerging bank units Scotiabank is acquiring do improve the bank’s market share, however, for assets with disclosed numbers, we have calculated that at least some of these units have been earning average or subpar returns on equity compared with our estimates of what the cost of equity might be in some of these countries. Finally, the bank’s main goal is to have outsized growth via exposure to these emerging markets, and yet year over year, based even on adjusted numbers, the bank is not noticeably outperforming the other Canadian banks for net income growth. For the whole second half of 2017, we called for Scotiabank to underperform, and that prediction has largely come true. With shares having underperformed peers, they are beginning to look a bit more attractive, but we still don’t see an outsized bargain at today’s prices. This may begin to turn around in mid to late 2019 and 2020, as the bank’s acquisitions finally begin to turn accretive, one-time charges dissipate, and growth in Canada may be slowing by that time.