2 financial stocks rated ‘Best Buys’

Toronto-based portfolio manager Mike Vinokur has named two financial stocks for his picks as currently-rated “best buys”. Canadian bank stock Scotiabank is “cheap on a P/E basis” and U.S. private equity stock KKR & Co. has “a very long track record of making their own partners and clients money”.

Whether or not the word “crisis” is actually written out using the words for “danger” and “opportunity” in Chinese, Mike Vinokur certainly sees an opportunity in the beating that the Bank of Nova Scotia’s (TSX─BNS) shares have taken in the market since the highs that it reached during the summer of 2014.

Mr. Vinokur is vice-president as well as portfolio manager for Trapeze Asset Management in Toronto. The analyst concedes that the Canadian bank stock, commonly known as Scotiabank, recently traded at a discount of close to 30 per cent compared to its share price in those heady days. Nevertheless, his faith that Scotiabank will rise again is bolstered by a host of positive metrics and business qualities.

Canadian bank stock’s drop belies true strength

“You’re getting a bank that’s cheap on a P/E (price-to-earnings) basis, that’s got a high level of capital, that has a very big international footprint,” says Mr. Vinokur.

“Based on an 11.5 or 12 P/E multiple, we can derive a very easy target of $72 for the stock,” he adds, roughly matching the bank’s rallying price in summer 2014. “There is upside to that estimate, based on overall growth and valuation multiple.”

According to the analyst, Scotiabank is likely trading at the cheapest valuation compared to the other major Canadian bank stocks on a forward basis, with a share price about nine times higher than estimated earnings per share in 2017.

Scotiabank offers an impressively high dividend yield of about 5.2 per cent based on the share price in mid-January and current annual dividend of $2.80 per share (paid out on a quarterly basis).

Mr. Vinokur also praised the Canadian financial stock as “Canada’s most international bank”, boasting a strong and growing presence in Latin America, the Caribbean, and Southeast Asia.

However, Scotiabank’s longtime and ongoing pursuit of expansion opportunities abroad might have been a double-edged sword.

Asked what caused the big 5 Canadian bank’s recent market woes, Mr. Vinokur says, “Partially, it’s because of their energy exposure and partially perhaps because they are exposed to Latin America and developing market countries.”

The analyst notes that credit issues are a greater concern in such markets relative to mature developed economies.

On the home front, Mr. Vinokur says credit issues related to energy investments and consumer debt, especially in areas affected by the energy industry’s troubles (such as Alberta, British Columbia, and Saskatchewan), could lead to more lagging share prices rather than a recovery.

However, the analyst says that at present, Scotiabank’s total exposure to energy or oil and gas is about 3.5 per cent of total loans, a level he considers acceptable.

“They have learned from the past, by and large. I think that they are managing the exposure very carefully, especially in light of where oil and gas prices are.”

Private equity firm moves toward recurring fees

Mr. Vinokur’s other “best buy” is less of a household name than Scotiabank, but still enjoys an excellent reputation in the right circles built up since the 1970s: global private equity investing firm KKR & Co. L.P. (formerly Kohlberg Kravis Roberts & Co.) (NYSE─KKR).

Although the company was originally founded in 1976, KKR only went public in 2010. Mr. Vinokur says KKR should appeal to “anybody who is looking to invest in a company that’s got a very long track record of making their own partners and clients money by finding very niche investing opportunities.”

Specifically, KKR has found such opportunities in credit and distressed areas of the market. The company currently has about US$100 billion in assets under management.

Based on the analyst’s “sum-of-the-parts” assessment, the entire business is worth between US$24 and US$25 per share. He points out, however, that the company has a book value of just US$12 and trades at about US$13.50.

Not content to rest on its laurels, KKR bought back $500 million worth of shares and simultaneously adjusted its dividend to a fixed amount, $0.16 per unit.

Mr. Vinokur says this global private equity investment bank has worked to pursue sources of income such as recurring management and performance fees that are more predictable than past moneymakers.

“Before, a lot of their income was derived from strictly private equity realizations and not asset management fees,” he says. Now, any unexpected gains from private equity are “just extra gravy.”

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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