Today’s e-mail will be jam-packed with information as we move through earnings season.
This week, we’ll discuss some Bull List stocks reporting earnings, open up our brand new Market Mindset events, and then go in-depth on the Canadian bank earnings.
Market Mindset
Our brand new Market Mindset segments are kicking off this Tuesday, March 7th, at 1 PM EST.
Although we plan to introduce fully private Market Mindset events where only members can discuss and ask questions with both Mat and I, in this month’s segment, we’ll be going over 3 key dividend mistakes and how we can fix them.
The segment will go live this Tuesday at 1 PM EST. There will be a live Q&A at the end. But don’t worry, if you cannot attend, there will be a video recording available to members.
As a member, you will not need to register for the event. Instead, closer to the event there will be a menu item in the “Account” section of your dashboard.
We’ll send out a reminder the morning of the 7th with more details.
Foundational Stock Earnings
Costco (COST)
Costco reported mixed second-quarter Fiscal 2023 results in which it topped earnings expectations but missed on revenue. The company reported diluted earnings per share of $3.30 when $3.19 was expected, and revenue of $54.24B came in about $1.4B lower than expected.
Costco has an exceptional record when it comes to hitting analyst estimates. So the fact that the quarter was, for the most part, on the mark is not surprising. Costco is one of the rare companies that post monthly sales numbers. This allows analysts to fine-tune targets heading into earnings, and as a result there tends to be fewer surprises come earnings time.
The company increased net sales by 6.5% compared to the second quarter of Fiscal 2022. When we look at adjusted comparable sales, which exclude gasoline and foreign exchange fluctuations, the company is still seeing significant growth in its international and Canadian markets. Comparable sales in Canada grew 9.6% year-over-year, while International sales rose 9.5% over the same timeframe.
Membership revenue continues to grow at a high single-digit pace, which could be accelerated even further by the rumoured increase in the membership fee. Management has stated the price will not increase right now. However, I’d be shocked if it didn’t increase soon.
Bull List Earnings
A&W Royalty (TSE:AW.UN)
A&W closed out Fiscal 2022 on a solid note. During the fourth quarter of 2022, same-store sales growth came in at 4.3%, and overall royalty income grew by 8.4% compared to the fourth quarter of 2021. Distributable cash per unit was virtually flat, as the company issued around 640,000 more units in the year, or around a 3% jump.
However, the company also did increase its overall store count by 2.5% to offset this partially. Its payout ratio closed out the year at 96.6%, which has been what the company has consistently managed to pay out for a long time.
We have to remember, this is a royalty company specifically designed to return most all of its earnings back to shareholders. So payout ratios near 100% are the norm.
Overall, it was business as usual for A&W, and it remains one of the best income options in the country with a defensive royalty structure, in our opinion.
You can have a read of our updated A&W report here
Canadian Bank overview
At this time, we feature 3 banks. Royal Bank is a Foundational Stock, and BMO and TD Bank are Bull List stocks.
However, we understand that the banks overall are a bellwether of the Canadian economy. If things get challenging, it will be felt across the economy. As such, we typically do deep dives into all of them come earnings time. Let’s go ahead and get started.
Of note, the Royal Bank, Bank of Montreal and Toronto Dominion Bank reports are updated and available on the dashboard. Please ensure you have images enabled in these e-mails, as we have numerous charts below.
Macroeconomic headwinds led to plenty of negative commentary and speculation leading into bank earnings season. How did they perform?
The results were decidedly mixed and there were plenty of warning signs for investors to digest. Let’s have a look at how Canada’s banks fared this quarter.
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We’ve certainly seen better. Now, results weren’t as bad as many pundits expected them to be, but they rarely ever are.
As the saying goes, the truth usually lies somewhere in the middle and this earnings season was no different.
Provision for Credit Losses
Let’s start with the most glaring impact – Provisions For Credit Losses (PCLs). This is a very important metric for the banks as it reflects credit quality. It is also a forward-looking number, as PCLs, in laypersons terms, are the money a bank sets aside to cover loans it expects to go unpaid.
To put it simply, it is a reflection of bad debt and despite it being an estimate, it is booked as a quarterly expense. If they over-estimate PCLs, it is likely you’d see a gain in this area instead of a loss.
The pandemic led to significant swings in PCL losses and gains because of how quickly things changed.
If PCLs rise, it is a sign that credit quality is deteriorating and is likely a sign of difficult macro-economic conditions.
With this in mind, it wasn’t surprising that some PCLs were materially revised upwards. As interest rates rise and inflation persists, certain banks foresee greater defaults on the horizon.
It is also important to note that while these are some big numbers, they still account for a very small percentage of overall loans. Here was the breakdown last quarter.
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The clear standout in this area was that the Canadian Imperial Bank of Commerce (CM) saw PCLs drop materially QoQ. It was interesting to see commentary around this as it was materially below the average analyst expectation of $336M.
It appears as though the bank has a positive outlook on retail, which is in stark contrast to some of the other banks.
The last time there was such a big disconnect between a bank and its peers on PCLs, it was the Bank of Nova Scotia and their underestimation of PCLs at the onset of the pandemic.
In subsequent quarters, BNS played catchup in terms of PCLs which led to several quarters of underperformance in terms of results and share price.
Interestingly, BNS was on the higher side this time around. This is not to say CIBC is underestimating but it is something worth monitoring as these disconnects among the Big 6 don’t happen too often. If we see CIBC play catchup much like the Bank of Nova Scotia did, it could lead to some volatility in 2023.
Net Interest Margin (NIM)
Another big impact was softer than expected net interest margin (NIM), a key profitability metric for banks.
NIM reflects the difference between interest earned (mortgages, loans, etc) vs interest expenses (savings, deposits, etc) expressed as a percentage of income generating assets.
Typically, in an environment of rising rates – NIMs expand and is a key growth driver for banks. However, given the current difficult economic environment driven in large part by higher inflation, the impact on NIMs hasn’t been as pronounced.
In fact, on the quarter the average NIM expansion on the banks was -2 basis points (bps) quarter over quarter (QoQ). That means that on average, NIM contracted from last quarter. Contracting NIMs in a rising rate environment really highlights the current economic situation.
One standout in this area was Bull List stock Toronto-Dominion (TD) which saw NIM expand by 6bps to 1.94%. That said, the improvement seems to be front-loaded as it does expect more moderate expansion for the balance of the year.
Overall, it was a very mixed quarter. In our opinion, the two standouts were TD Bank and National Bank, while the biggest laggard was once again the Bank of Nova Scotia. The bank’s international segment continues to be a drag.
We aren’t quite sure what it will take for the company to succeed here, but its been almost a decade that BNS’s over-expansion led to an international re-focus on Latin America. Unfortunately, the expansion still has not paid dividends.
Dividend Patterns
Speaking of which, there were no dividend raise announcements this past quarter – somewhat of a rarity of Canadian banks which typically see at least one raise.
However, the pandemic disrupted regular dividend patterns and it remains to be seen if new patterns will emerge or if it will continue to be inconsistent.
Should new patterns emerge, then we’d expect bi-annual raises from BMO, CM, NA, and RY next quarter. TD and BNS are committed to annual increases which won’t occur until the fall.
Closing Thoughts
If we are being honest, the quarter wasn’t a great one as results are starting to reflect a difficult macro-economic environment.
That said, despite some knee-jerk reactions to bank earnings which saw many large drops the day of earnings, many rebounded to close out the week. Patience will be needed over the next few quarters while the markets wait for interest rate stability.
In the meantime, Canadians can accumulate some of the best dividend stocks in the country at prices below historical averages. In fact, I (Dan) added to my Royal Bank position on weakness post earnings last week.
While banks could still see some downside, we believe that the headwinds are currently priced-in given the discounts.
In fact, only CIBC is trading at a slight premium, and this is likely because the bank spent years underperforming and trading at a big discount to peers. As of writing, BMO, TD, and NA are all trading at double-digit discounts to their historical valuations.
Why is this important? Banks have a tendency of trading in line with historical averages and typically, buying when they trade at discounts relative to historical averages correlates strongly to outperformance.
The only bank that has bucked this trend the last half decade has been Bank of Nova Scotia.
