Canada’s sixth largest bank, the National Bank of Canada (TSX:NA) has performed well since the start of 2014 with its share price running up by 22% over that period. However, there are signs the time has come for investors in National Bank to consider taking profits and reducing their exposure.
First, the bank is primarily a regional player centered on Quebec and focused on growing its business domestically with little international exposure.
Canada’s housing boom, fueled by cheap credit and solid economic growth, has been a boon for Canada’s banks, allowing them to grow earnings and report record profits. But with signs the housing market has entered bubble territory, those banks with the most Canadian exposure, like National Bank and Canadian Imperial Bank of Commerce (TSX: CM) (NYSE: CM), will be the hardest hit.
At the end of its fiscal third quarter 2014, Canadian residential mortgages made up 47% of total loans under management or LUM, highlighting the impact a housing crash could have on the bank.
National Bank is also heavily exposed to the commodities and energy sectors in Canada with 8% of its LUM originating in those sectors. This emphasizes the impact on National Bank’s earnings with both sectors suffering because of softer commodity prices.
These factors, in conjunction with its lack of offshore businesses will hurt National Bank’s ability to continue growing earnings. In contrast, those banks with international exposure, particularly to the rapidly recovering U.S. economy or fast growing emerging economies of South America, have far better future growth prospects.
This includes Toronto Dominion Bank (TSX: TD) (NYSE: TD) and the Bank of Montreal (TSX: BMO) (NYSE: BMO) which have built significant U.S. franchises and the Bank of Nova Scotia (TSX: BNS) (NYSE: BNS), which has established a presence in the rapidly growing emerging markets of Colombia, Peru and Chile.
And another thing
Not only do its prospects for growth appear worse, National Bank’s share price has performed very well relative to its peers.
Again, year-to-date, National Bank is up by 22%, whereas Toronto Dominion has only gained 7%, the Bank of Montreal 9%, CIBC 8%, Royal Bank of Canada (TSX: RY) (NYSE:RY) 9% and the Bank of Nova Scotia -1.3%.
This strong performance now makes National Bank appear expensive to a number of its peers with a price-to-book ratio (P/B) of 2.1, particularly when those peers have far better growth prospects. This compares to the Bank of Nova Scotia with a P/B of 1.9, the Bank of Montreal’s P/B of 1.8 and Toronto Dominion’s P/B of 2.
In my opinion, the run the stock has had, its elevated valuation, and the limited growth prospects due to its dependence on the domestick market put National in the back seat when I’m considering which banks to add to my portfolio.
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Matt Smith has no position in any stocks mentioned.