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Morningstar | RBC Wraps Up a Strong 2018, Maintains Medium-Term Guidance for 2019

Wide-moat Royal Bank of Canada reported good fiscal fourth-quarter 2018 results, and our long-term thesis on the firm remains unchanged. GAAP earnings per share came in at CAD 8.36, up 10.6% compared with 2017 and just slightly above our CAD 8.33 expectation. We are increasing our fair value estimate for the Canadian shares to CAD 111 from CAD 109, and due to changing exchange rates, we are decreasing our fair value estimate for U.S. shares to $83 from $84 per share.

The return on equity improved during the quarter, to 17.6%, and the return on equity for the full year was also 17.6%. These are exceptional results and will likely keep RBC as one of the top two Canadian banks by this metric. Given these returns on equity, EPS growth of over 10%, and a 45% dividend payout ratio for the year, the bank met all medium-term objectives. Further, management maintained these goals for 2019. The bank's common equity Tier 1 ratio increased to 11.5%, giving RBC plenty of room for further investment as the bank beefs up organic growth efforts, particularly in the United States. Credit quality remained excellent, as RBC's gross impaired loan ratio declined to 37 basis points, its provision for credit losses, or PCL, ratio remained fairly stable at 20 basis points, and delinquency rates remained range-bound.

Overall, RBC is gaining share in key markets in Canada and executing well on its cross-selling measures within the former City National segment. Growth was again harder to come by for the investor and treasury services segment, where net income was roughly flat for the year, but growth in all other segments remained robust. The Canadian banking segment remains on track for continued operating leverage as expense control remains solid, assets are expected to grow modestly, and net interest margins should expand. Wealth management has seen continued gains, as the City National acquisition has gone well, and RBC remains one of the top asset managers and gatherers in Canada, gathering more than their share of net sales during 2018. The bank also believes it can continue to grow the insurance business, with a focus on further selling home and auto insurance.

Management gave updated disclosures around energy exposure, where Canadian heavy oil exposure makes up only 0.2% of total loans. We also note that RBC, like many of the Canadian banks, downsized and strengthened its oil loan books following price declines in 2016. The mortgage book also remained relatively benign, with no real changes in delinquencies, and only a slight uptick in PCLs. We would expect growth to slow for this portfolio over the medium term and don’t see any credit disasters looming in the short term here for RBC.