BANK STOCKS

The most Canadian of the banks versus the most

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DAVID MILSTEAD

Special to The Globe and Mail

Published Friday, May. 09 2014, 5:56 PM EDT

What’s the matter with Canada? Maybe not so much at all, if the most Canadian of banks is also the

best-performing bank stock of 2014 – and the most international bank is the worst.

Canadian Imperial Bank of Commerce, regarded as the one major bank with the most exposure to

the Canadian consumer, is up more than 7 per cent year-to-date, leading its peers. The shares of

the Bank of Nova Scotia, long feted for its global footprint and exposure to fast-growing emerging

markets, are essentially flat, ranking last among the big banks.

To some extent, the results seem to mirror investor sentiment. Even as consumer lending is slowing,

the long-forecast collapse of the Canadian housing market still has not occurred, and the stocks

most sensitive to it, like CIBC, have overcome significant pessimism. At the same time, emerging

markets have generally performed poorly in 2014, taking down any number of names closely linked

to the global growth thesis.

It’s not just blind investor sentiment driving the performance of CIBC and Scotiabank’s shares,

however. Each has, in its own recent results, earned its place at the top and the bottom of the pack

in 2014 returns. CIBC reported an impressive first quarter, convincing many investors the bank is

moving solidly away from its missteps in the financial crisis. Scotiabank, by contrast, continued to

show little earnings growth in its vaunted international segment, denting its best-in-class growth

thesis.

The result is that CIBC isn’t as cheap as it used to be, and Scotiabank isn’t nearly as expensive. But

there’s a good chance the trends will continue for the remainder of the year, making CIBC worthy of

a closer look, with Scotiabank relegated to more of a long-term play.

There were many reasons CIBC trailed peers as recently as last year. The bank had mostly

recovered from its U.S. misadventures from a decade before when it got damaged by the 2008-09

financial crisis more badly than any other Canadian bank. Then, in 2013, it revealed its partnership

with the Aeroplan credit card was unravelling. It was also revamping its mortgage business.

The bank’s first-quarter results, released in late February, easily beat analyst estimates and

suggested CIBC is moving past any number of operational issues. The shares, trading around $90

before the report, have climbed steadily, closing at $96.84 Friday. The recent news that CEO Gerry

McCaughey will retire, with no clear successor in place, has not stopped the rise.

“Pretty much everything went right for CIBC,” analyst Meny Grauman at Cormark Securities wrote

after the earnings report. He raised his target price to $107, saying he expects CIBC’s price-toearnings

multiple to rise as the market buys into the CIBC story. “Execution appears to be strong

and progress is being made.”

The analysts at Veritas Investment Research have been more bearish on the Canadian housing

market than most, and that led to a “sell” rating on CIBC – until last year, when the firm began to

believe analysts were being too pessimistic about the possible damage to CIBC of giving up a

portion of the Aeroplan business and launching its own travel-rewards credit card.

“We viewed estimates as too low relative to the underlying earnings capabilities of the bank,” says

Veritas analyst Kyle MacDonald, who says that many analysts continue to overestimate the

negative Aeroplan effects. The full impact will be seen in the second quarter, he says. “[Our

recommendation] has worked out well so far, but the caveat is that it’s a short-term thesis.” His

target price is $100.

Typical of the skepticism is RBC Dominion Securities Inc.’s Darko Mihelic, who sees CIBC missing

out on $381-million in earnings in 2014 and 2015 from the loss of Aeroplan. He also believes CIBC’s

retail banking revenue growth will lag peers. His post-earnings report was titled, It Will Take More

Than One Strong Quarter to Change our Thesis (But It’s a Start).

In arriving at his $98 target price, Mr. Mihelic assigns CIBC a price-to-earnings multiple of 10.5 on its

2015 earnings, the lowest of any of the major Canadian banks. His “upside scenario” multiple of

13.2, based on greater-than-expected economic growth in North America and a host of other

positives, yields a price of $123.

Scotiabank, by contrast, can’t quite claim everything is going right. Its international segment reported

loan and deposit growth, but it also reported higher expenses, including more money set aside for

potential loan losses.

“International credit quality isn’t quite the same as it is back home, and with the expansion in some

of these emerging markets, you’re going to get higher and bumpier provisions and credit losses,”

says analyst Dan Werner of Morningstar, who has a $61 “fair value” estimate on the company

shares, which closed Friday at $66.78.

Mr. MacDonald of Veritas, who has a “sell” rating and $66.90 target price, said investors are finally

souring on the international growth story that kept Scotiabank shares at a premium to the peer

average. “Over the past year and half to two years, there actually has been no growth in the

international segment. You’re seeing credit losses and expenses rising and revenue not rising fast

enough to meet the headwinds they’re facing. Until it turns around – and it may – the overhang will

continue on the stock.”

Mr. Grauman of Cormark, who has a “market perform” rating and $70 target price, argues that while

some emerging markets are expected to grow at a faster rate than the major developed nations over

the coming years, “that gap is getting smaller while the risk is getting larger.”

He says that while Scotiabank likes to emphasize that its international business is built around the

more stable Latin American economies of Chile, Peru, Mexico and Colombia, Scotiabank

Economics’s own forecasters believe real GDP growth in those countries will come in mostly at or

below their long-term rates in 2013 and 2014 while Canada and the U.S., by contrast, will come

close to meeting or exceeding their long-term growth rates in the next couple of years.

That may suggest that a close-to-home focus might finally work in CIBC’s favour for at least the

remainder of 2014 – and defer the Scotiabank success story for the longer term