| Bank Of Nova Scotia ( BNS, Toronto and New York) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)' disclosure of share ownership: | The Author(s) hold no shares |
| Based on financials from: | 2005 Y.E. + Q3 2006 |
| Last updated: | 9-Oct-06 |
| Share Price At Date of Last Update: | $48.20 |
| Currency: | $ Canadian |
| Current Rating (Company Rating does not consider the circumstances of any individual investor and is therefore not a recommendation and is not Investment Advice): | Buy rated at $48.20 |
| DESCRIPTION OF BUSINESS: The Bank of Nova Scotia originated in 1832 and has become an international banking institution spanning almost 50 countries with almost 2000 branches and 50,000 employees world wide and 10 million customers. Scotia Bank has three primary arms which it does business through. Domestic banking in Canada, International banking and Scotia Capital. Earnings from each division are 42% from domestic, 27% from International and 31% from Scotia Capital for fiscal 2005. | |
| RATING: The graph shows that earnings growth would qualify it as a "great company" although the revenue growth rate has been modest. The value ratios in isolation indicate a Buy or Strong Buy rating. Management seems to have a good understanding of the competitive environment and what they need to do to grow. Business outlook looks positive but competition may heat up domestically and that may squeeze margins further. Scotia bank is aggressively pursuing growth opportunities in Mexico, the Caribbean and Central America. Scotia bank passes all of the Buffett tenants, intrinsic value marginally, except for ease of understanding. Porter analysis does point out that banking is an attractive industry for those already in it. Domestically new competitors are not going to appear which means that the Chartered banks will retain their comfortable market shares. Scotia earned over 40% of its earnings from domestic banking in 2005. If current economic conditions continue Scotia bank should do well by maintaining market shares and revenues domestically and growing them in international markets. The major risk factor would be a recession leading to loan losses. Overall, we rate Scotia Bank a Buy. | |
| RISKS: Scotia bank operates in a business environment with many risks but it would take a catastrophic event for Scotia, or any Chartered Bank, to be overwhelmed and not be able to bounce back. Scotia bank is expanding in Mexico, the Caribbean and Central America. We personally think that those markets may not be mature and offer huge potential but are much riskier relative to mature markets Canada, US and Europe) and may expose Scotia bank to increased loan losses if things go sideways for them. Scotia bank did have a misstep in Argentina a few years back that cost them. Let's hope they learned something from that. Globally Scotia bank is a small fish and needs to be smart with its acquisitions to be able to grow internationally. For a full discussion of risks that Scotia Bank is exposed to see the annual report. It has a full break down of the inherent risks. | |
| INSIDER TRADING / INSIDER HOLDING: Checked SEDI from May 01, 2006 to October 09, 2006. Quite a bit of recent activity in September . Nineteen insiders exercised options and sold the shares. Rick Waugh exercised 192,250 options and sold 172,250 shares in September. Since the executives receive a large amount of options for compensation it is not surprising to see them exercising and then selling them. We don't really take any signal from it. Overall, the Insider Trading / Insider Holding signal is neutral. | |
| WARREN BUFFETT's TENETS: (See Robert Hagstrom's book - The Warren Buffett Way) - Not that simple to understand due to multiple divisions and global operations (fail), good recent profit history (pass), prospects for average returns (pass), apparently candid ethical management (pass), a high ROE (pass), high profits on sales (pass) , a low debt ratio (pass), little chance of permanent loss of capital (pass) low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) and arguably selling at a discount to intrinsic value (pass). | |
| RECENT EARNINGS AND SALES TREND: The graph of EPS and RPS show both having a positive trend since 2002. For the nine months ended Q3, 2006 RPS and EPS have increased 8% and 12.7% respectively over same period last year. For Q3, 2006 RPS have increased 11% and EPS have increased over 20% year over year. Domestic Banking net income stayed stable but International Banking and Scotia Capital both had solid net income gains in Q3 '06 over Q3 '05. Recent acquisitions contributed greatly to gains in International Banking. Scotia Capital did see trading revenues decrease but these were offset by loan portfolio growth. | |
| VALUE AND GROWTH RATIOS: The Price to Book ratio is not particularly attractive at 2.82. The current P/E is 13.9 which is attractive but banks historically have lower P/E's than the market as a whole, due to potential risks. Adjusted compounded 5 year growth in earnings per diluted share is strong at 11.7% and but only 4.8% in revenue per diluted share. Dividend yield has been a respectable 3.2%. Adjusted 2005 fiscal ROE is an excellent 21%. Interim ROE is also about 21%. Intrinsic value per share is calculated as $49.21 with 5% growth and the P/E remaining at 14 and more optimistically calculated as $61.29 assuming 10% growth for 5 years and the P/E remaining at 14. This implies a Price to Value ratio of 98% to 79% respectively. These ratios in isolation would indicate a Buy or (higher) Buy rating. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | BNS, Toronto and New York |
| Currency: | Canadian $ |
| Category: | income |
| Contact: | investor.relations@scotiabank.com |
| Web-site: | www.scotiabank.com |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $11,000.0 |
| Latest four quarters annual earnings $ millions: | $3,462.0 |
| P/E ratio based on latest four quarters earnings: | 13.9 |
| Latest four quarters annual earnings, adjusted, $ millions: | $3,462.0 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: Earnings have been adjusted for a loss on disposal of a subsidiary operations( Argentina), 2002 and 2003, and a one time increase in the general provision for credit losses, 1999. | |
| Quality of Earnings Measurement and Persistence: Earnings are of high quality because banks by nature earn income mostly from fees and net interest income. That being said persistence may be an issue if the interest margin declined and credit quality declines resulting in larger loan losses. However, Scotia Bank is very diversified and earns fee income from various sources and banking operations are very well diversified. | |
| P/E ratio based on latest four quarters earnings, adjusted | 13.9 |
| Latest fiscal year annual earnings: | $3,184.0 |
| P/E ratio based on latest fiscal year earnings: | 15.2 |
| Fiscal earnings adjusted: | $3,184.0 |
| P/E ratio for fiscal earnings adjusted: | 15.2 |
| Latest four quarters profit as percent of sales | 31.5% |
| Dividend Yield: | 3.2% |
| Price / Sales Ratio | 4.39 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 2.82 |
| Quality of Net Assets and Book Value Measurement: Assets and liabilities of Scotia bank are of high quality and very reliable. Assets are loans which are subject to general and specific allowance or credit losses has been dropping and is expected to not increase or continue dropping if economic conditions and business conditions continue. Liabilities are very liquid and therefore very reliable. Banks operate with extremely high levels of leverage therefore book value would be greatly affected if loan losses increased substantially. | |
| Number of Diluted common shares in millions: | 998.0 |
| Controlling Shareholder: No one share holder can hold more than 10% of shares by the law, The Bank Act. | |
| Market Capitalization $ millions: | $48,103.6 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 5% |
| Interest-bearing debt as a percentage of common equity | 67% |
| Current assets / current liabilities: | not available |
| Liquidity and capital structure: Highly leveraged but does carry substantial liquid cash resources. Provision for credit losses remained in line with Q3 2005, from $85 million to $74 million. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on ending equity: | 20.3% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 21.1% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 7.2% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 4.8% |
| Volatility of sales growth per share: | Modest but steady |
| 5 Years compounded growth in earnings/share | 11.7% |
| 5 years compounded growth in adjusted earnings per share | 11.7% |
| Volatility of earnings growth: | Strong and reasonably steady growth |
| Projected current year earnings $millions: | not available |
| Projected price to earnings ratio: | not available |
| Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? | growth is steady |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 11.6% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 5.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 10.0% |
| OUTLOOK FOR BUSINESS: Domestically margins are being squeezed and there will be increased competition from the other Chartered Banks. Royal Bank has announced it plans on increasing branches domestically. The housing market is beginning to cool across the country which will impact Scotia's domestic earnings. Growth is anticipated in the International business line with additional acquisitions and growth in Latin America. Currency Translation losses have impacted overall growth from these regions. Credit quality has been stable with low credit losses. | |
| Estimated present value per share: I calculate $49.21 if earnings per share grow for 5 years at the more conservative rate of 5% and the shares can then be sold at a P/E of 14 and $61.29 if earnings per share grow at the more optimistic rate of 10% for 5 years and the shares can then be sold at a P/E of 14. Both estimates use a 8% required rate of return. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry rather than any particular company.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. barriers to entry. Virtually impossible to create a financial institution from scratch that could compete with the Banks (pass). No issues with powerful suppliers because of the breadth of banking services Scotia offers (pass). No issues with dependence on powerful customers due to large customer base (pass), no potential for substitute products as banking services are unique to this industry (pass) no tendency to compete ruinously on price since the banks just increase fees. Only interest margin could be factor but that would affect all financial institutions (pass). Overall this industry appears to be attractive. | |
| COMPETITIVE ADVANTAGE: Well diversified across the globe in many financial services. But relative to other global banks the Canadian Chartered Banks are very small and are protected in the Canadian Market place. | |
| RECENT EVENTS: Announced that Scotia Bank will be offering a zero down payment mortgage domestically. Scotia Bank also plans on increasing its branch presence in Canada by 30-50 branches and 100 branches in Mexico. | |
| ACCOUNTING AND DISCLOSURE ISSUES: Annual report is very detailed with good disclosure and discussion on all current and expected operations. | |
| COMMON SHARE STRUCTURE USED: one share one vote | |
| MANAGEMENT QUALITY: Based on results the executive team understands their objectives and knows how to execute a plan to grow. The executive team is also forward thinking by driving revenue based initiatives, using strategic acquisitions and effectively manage capital to grow. | |
| EXECUTIVE COMPENSATION: Base salaries are not excessive with the CEO earning $1 million in salary with a bonus of $1.5 million for 2005. Equity compensation using Performance share units and Stock options added $6 million to the CEO's compensation for 2005. Total compensation including equity compensation earned the top six executives over $1 million in total compensation for 2005. By today's standards this does not seem overly excessive and the equity compensation gives the executives motivation to ensure Scotia continues to perform and increase share prices. | |
| BOARD OF DIRECTORS: Scotia bank has sixteen directors. The majority of them are independent with no large business relationship with the bank. Some very well known names sit on the board, Gerald Schwartz of Onex and Paul Sobey of Empire. Scotia bank enacted a formal Corporate Governance Policy in 2002 and best practices to ensure an independent board. Directors are expected to own at least $300,000 in bank common shares to align their interest with shareholders. The current members are from diversified business backgrounds with the majority of them with more than 5 years experience on the board. Seems like a very qualified board of directors. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the companies growth prospects. Despite this diligence my analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are "generic" in nature and do not take into account the unique circumstances and risk tolerance of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. InvestorsFriend Inc. itself does not have a position in any of the indicated securities while the authors may have a position. | |
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