National Bank of Canada

English: The National Bank of Canada tower in Place d’Armes (Photo credit: Wikipedia)

NA : TSX : C$77.02
BUY 
Target: C$89.00

COMPANY DESCRIPTION:
National Bank of Canada is an integrated group that provides comprehensive financial services in its core market in the province of Quebec.
National Bank offers a full array of banking services, including retail, corporate and investment banking. National Bank has over $176 billion in assets and employs over 19,000 employees.

UPGRADING TO BUY ON RELATIVE VALUATION AND IMPROVED OUTLOOK ON CAPITAL

NA reported core Q2/13 EPS of $2.08 (up 6% YoY), above our estimate and consensus of $1.97. Relative to our estimate, stronger capital markets related revenue (trading particularly) was partially offset by higher PCLs and noninterest expenses. NA raised the dividend as expected.
NA’s BIII CET ratio increased to 8.3% up from 7.9%, reflecting earnings, including the $100 million ABCP gain. The bank announced a 2% ($250
million) NCIB this quarter. We model for quarterly repurchases of 600,000 shares to arrive at a total share repurchase of 2.5 million shares, slightly under the 3.25 million authorized. With our assumed share repurchases, the bank’s Basel III CET ratio continues to improve, climbing from 8.3% this quarter to 8.7% by the end of 2014.

After deducting 30 bps for the CVA adjustment in 2014, the ratio should remain well above 8%.
P&C earnings were up 1% YoY on operating leverage of 0.7% offset by higher PCLs. P&C net interest income was weak, increasing only 1.6%, reflecting 10% volume growth offset by lower NIM YoY. NIM of 2.30% was down 13 bps from last year but was down only 1 bps QoQ. After delivering very weak NIM performance in domestic retail throughout most of the year, National’s QoQ P&C NIM performance (down 1 bps) was solid.
Our target price increases to C$89.00 from C$88.00 (target discount unchanged at 10%). At 20%, upside potential to our target price is as high as
other BUY-rated stocks. While we acknowledge that the current quarter’s results were largely driven by higher CMRR and that P&C remains weak,
given the bank’s discount valuation and our revised outlook on NA’s capital outlook, we are upgrading NA to BUY from Hold.

Our typical pattern with NA is to upgrade the stock when the discount to the group is well ahead of 10% (currently 13%) and downgrade once the discount narrows materially. In this context, as well as the fact that the earnings beat was not particularly high quality, we view our upgrade as a short term call.