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Ignore Bank of Nova Scotia’s Earnings Miss and Add it to Your Portfolio

Bank earnings season recently ended, and in a rare event, Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) was the only major bank to experience an earnings miss. Despite the mixed reaction towards the bank this miss sparked, including a minor sell-off, which now sees it down by just under 2% for the month, it remains a solid long-term growth prospect.

Now what?

Bank of Nova Scotia is Canada’s most international bank. It has established a sizable banking franchise in Latin America.

Net profit for the first quarter 2017 came in at $2.01 billion, of which, almost a third was generated in its international banking business. This also represents a 10% increase over the same period in 2016 and attests to the bank’s ability to unlock value for shareholders, regardless of the difficult operating environment.

Even the harsh economic environment that exists in Latin America, where the majority of the Bank of Nova Scotia’s international business operates, did not curtail growth. Net interest income popped by just over 3%, and net income was up by an impressive 9%.

That difficult operating environment is improving despite the rising level of uncertainty over the global economic outlook.

Economic growth south of the border and in Latin America is on the up and up, boding well for a better second quarter for Bank of Nova Scotia.

In fact, higher oil, metals, and coal prices should spark a solid uptick in the bank’s international earnings. This is because the Latin American nations, where it has its largest operating franchises, Chile, Colombia, Peru, and Mexico, are highly dependent on the extraction and exportation of commodities to drive economic growth.

Higher oil and coal prices have already benefited Colombia, Latin America’s fourth-largest oil producer. The Andean nation’s fourth-quarter 2016 GDP grew by 1.6% — 40 basis points higher than the previous quarter and 20 basis points higher than the consensus forecast.

Meanwhile, high metals prices, notably copper, gold, silver, and zinc, are acting a as powerful tailwind for economic growth in Chile and Peru.

As those economies pick up steam, business activity and consumption will rise, causing the demand for credit to grow. This will give Bank of Nova Scotia’s lending revenues a healthy boost because of its ability to generate a net interest margin that is almost double that of its Canadian business.

Investors are also forgetting that the bank’s Canadian business continues to perform strongly, despite economic headwinds over the last two years. That business is delivering an incredible return on equity (ROE) which, over the last two years, has averaged an impressive 22%. This is more than double the average ROE of 9% generated by U.S. banks over the same period.

The rebound in crude will also lift the bank’s profitability and reduce the level of risk in its lending book.

You see, higher oil prices will reduce the likelihood of further defaults on loans to the oil industry and allow the bank to release lending loss provisions as the degree of risk decreases. Already, the value of impaired energy loans has fallen by 9% compared to the previous quarter and is 12% lower than a year earlier. As long crude prices keep recovering, this trend will continue. 

So what?

The relatively solid first-quarter results allowed management to reward investors with yet another dividend hike, which is the seventh straight year in which the bank has done so. This means investors will continue to be rewarded by a generous and sustainable 4% yield as they wait for Bank of Nova Scotia’s prospects to improve and its stock price to appreciate.

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Fool contributor Matt Smith has no position in any stocks mentioned.

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