‘Best Buys’ from leading analysts

Analysts follow as many as 20 stocks, most of which are rated “buys”. Of those buys, an analyst has one or two special favourites seen as most suitable for new buying. This column is devoted to those one or two favourite “best buys”.

best_buysWhen the new year got underway, Toronto-based Credit Suisse analyst Nick Stogdill named Royal Bank of Canada (TSX—RY; NYSE—RY) and Manulife Financial Corp. (TSX—MFC; NYSE—MFC) as two of his ‘top picks’ for 2018.

Following the release of both financial institutions’ latest quarterly results, Mr. Stogdill stands by his earlier rosy prognoses, again declaring them ‘top picks’ (or ‘best buys’ for our purposes).

The analyst explains that his faith in Royal Bank is based on several factors: a well-diversified business generating above-average earnings and dividend growth; market-leading business segments with scale in Canada; and its potential for U.S. expansion beyond expectations as the economy there strengthens.

For the first quarter of its 2018 fiscal year (quarter ended Jan. 31, 2018), Royal Bank reported combined adjusted earnings per share (EPS) of $2.14, a 14 per cent jump year-over-year.

“Capital markets was the biggest contributor to the EPS beat this quarter, but growth excluding capital markets of 10 per cent was strong, led by wealth and Canadian banking.”

Mr. Stogdill praises Royal’s Canadian retail banking, wealth management and capital markets arms for their impressive reach. Because of its heavy yet varied market penetration, Royal Bank has been able to reinvest in its franchises but can also survive shakier growth prospects should they arise, he says.

“RY is the only bank to take restructuring charges within core earnings, providing a modest tailwind for 2018. Furthermore, the bank raised its dividend by 10 per cent last year. By comparison, its peers increased their dividends by an average of seven per cent.”

By segment in the first quarter, Royal’s capital markets earnings grew 13 per cent year-over-year and 28 per cent quarter-over-quarter. Meanwhile, Canadian banking earnings and wealth management jumped, respectively, by nine per cent and 33 per cent year-over-year, or seven per cent and 17 per cent quarter-over-quarter.

Mr. Stogdill says of the domestic banking business, “With strong operating leverage to start the year, RY expects improvement to moderate next quarter to the one to two per cent range before increasing towards the higher end of the two-to-three per cent range in the second half of 2018. “For net interest margins, RY expects an increase of three to five basis points for the remainder of the year, from the fiscal 2018 first-quarter level of 2.68 per cent. Lastly, as previously telegraphed, RY expects mortgage growth to moderate to the mid-single digits and overall loan growth to be supported by business lending.

“RY has picked up market share on the business side, specifically within real estate, agriculture, retail and wholesale, and customers are generally looking (past) NAFTA concerns although it remains a risk for long-term investment.”

Mr. Stogdill stresses, however, that the bank is relatively well-positioned for NAFTA-related issues since any earnings losses will be partly made up by a favourable exchange rate on earnings coming from U.S. business. He also predicts that the U.S. wealth and capital markets divisions will gain business thanks in part to last December’s tax package.

Royal Bank reclaimed its status as the biggest lender in the country in the recent past quarter. It reported that it held a total of $1.28 trillion in assets at quarter’s end, compared to Toronto-Dominion Bank’s $1.26 trillion, pushing the latter to second-largest. TD first overtook Royal as Canada’s biggest bank in 2013, setting off a recent tug-of-war. Historically, Royal Bank has occupied the top spot.

Mr. Stogdill assigns a target share price of $114 to Royal Bank.

Manulife is the analyst’s favourite among Canadian life insurance companies.

He says, “It offers double-digit EPS growth of 13 per cent, the highest in our coverage universe, with upside if rates move higher and a reasonable valuation. Furthermore, we believe downside risk relative to 2016 to 2017 is lower, with MFC managing through a number of headwinds, including unexpired risk reserve charges, long-term care reserve strengthening and negative investment experience from low oil and gas prices.

“We believe double-digit EPS growth is achievable even in a flattish rate environment reflecting underlying organic growth, particularly in Asia as it benefits from recent acquisitions and a pickup in investment gains of up to $400 million in 2018. Improved policyholder experience, lower hedging costs and better credit experience could also support growth.”

The company reported 2017 fourth-quarter core EPS of $0.59, a six per cent drop year-over-year, though the analyst points out that core EPS actually rose 13 per cent, if one-time items from 2016’s fourth quarter are not counted.

This is an edited version of an article that was originally published for subscribers in the April 6, 2018, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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