Royal Bank of Canada (TSX:RY)(NYSE:RY) is down about 9% for the year, and investors are wondering if the recent pullback is a good opportunity to start a position in the stock.
Let’s take a look at the current situation to see if this is the right time to add Royal to your portfolio.
Earnings
Royal delivered solid result for its third quarter, which ended July 31. The bank reported net income of $2.475 billion, a 4% gain over Q3 2014. Investors should see the strong numbers as an indication of management’s ability to produce higher profits in a difficult environment.
Royal relies on Canada for 63% of its revenue, while 19% come from the U.S., and the international operations account for the remaining 18% of profits. This diversification provides a good hedge against the weakness facing the Canadian economy, and investors should see the U.S. group become more significant in the coming years.
Royal is spending US$5.4 billion to buy City National, a California-based wealth management and commercial banking company. The deal should close by the end of this year and contribute to earnings in 2016.
Dividend safety
Royal recently bumped up its quarterly dividend by 3% to $0.79 per share. The company has increased the payout nine times in the past five years, and investors should see the trend continue.
The current distribution is very safe and pays a nice 4.3%.
Canadian economic risks
Royal finished the third quarter with $201 billion in Canadian residential mortgages on its books. That sounds like a lot, and it is, but the number is actually quite reasonable when compared with the other big banks on a market cap basis.
In the Q3 statement Royal said 39% of the portfolio is insured and the loan-to-value ratio (LTV) on the uninsured mortgages is 55%. The insured component is lower than the other banks, but the LTV on the rest is good. Alberta represents about 15% of the mortgage loans.
The housing market would have to drop significantly in a short period of time for Royal to incur any material losses. At the moment, analysts expect a gradual pullback rather than a bursting of the bubble.
The other concern is exposure to oil and gas companies. Royal’s outstanding wholesale loans to the energy sector represent just 1.6% of the total loan book. In the Q3 earnings statement the company said it hasn’t seen any significant problems with the segment. The total exposure is about $7.5 billion.
Should you buy?
Royal is a great long-term investment. The stock currently trades for just 10.6 times forward earnings, which is very attractive compared with the historical average.
The company is well capitalized with a CET1ratio of 10.1%, so it is more than capable of riding out the current market headwinds.
Buy-and-hold investors should consider adding the stock to their portfolio at this price point.
