Canadian bank stocks are under an unfathomable amount of pressure right now. They’re facing a perfect storm of headwinds, beyond even the one-two punch of the coronavirus pandemic and OPEC+ breakdown.
The banks were already down due to a downturn in the Canadian credit market. With the Bank of Canada (BoC) lowering interest rates to 0.25%, net interest margins (NIMs) stand to become razor-thin.
Small-to-medium-sized businesses and energy firms will likely be significant sources of soured loans. Soaring provisions and lower loan growth at lower margins is setting the stage for a very bleak 2020. As a result, many bank stocks have crashed violently. These include top dog Royal Bank of Canada (TSX:RY)(NYSE:RY) and perennial underdog (and under-performer) CIBC (TSX:CM)(NYSE:CM).
In a classic top dog versus underdog comparison, we’ll have a brief look at the two banks to see which is the better buy at today’s valuations.
Royal Bank stock
Royal Bank was dealt a tough hand with the gloomy macro picture. But it has played it better than its peers. And the results? They speak for themselves. Royal Bank stock has taken minimal damage, with shares currently down just over 23% from all-time highs.
The bank’s capital markets and wealth management segments were bright spots in the first quarter. Moving forward, momentum in these two businesses could continue. As the bank navigates industry pitfalls, I wouldn’t be surprised to see Royal produce mid-to-high single-digit earnings per share growth, while its peers struggle to keep EPS growth out of the red.
At time of writing, Royal Bank stock trades at 9.1 times next year’s expected earnings and 1.5 times book. Both are substantially lower than the stock’s five-year historical average multiples of 11.4 and 2.1, respectively.
Over the last year, Royal Bank has shown it’s the king of the Canadian banking scene, and right now shares are trading at a nice discount. Although the discount isn’t as steep as some of the harder hit banks, Royal seems to have a very favourable risk/reward outlook as we head into the latter part of a year that’s sure to be full of pain and negative surprises.
CIBC is a perennial underperformer. It got caught with its pants down prior to the financial crisis, and despite making progress since 2008, I think it stands to be hit the hardest come the next economic meltdown.
CIBC’s first-quarter report included a $339 million restructuring charge, which is expected to produce $260 million in run-rate savings by the end of 2020. As the lights are dimmed on the Canadian economy, CIBC stands to be most impacted, as it still has the least amount of geographic diversification relative to its peers.
Moreover, one must not rule out the chance of a catastrophic Canadian housing market meltdown. If it happens, CIBC will get crushed with its massive book of uninsured mortgages. The Canadian credit downturn hit CIBC the hardest, and as pressures mount, I’d demand an enormous discount on shares of CIBC relative to its peers.
At time of writing, CIBC trades at 6.8 times next year’s expected earnings, which is a bottom-of-the-barrel multiple. Indeed, CIBC is the cheapest stock based on traditional valuation metrics, but that doesn’t mean it’s the most undervalued, given its higher set of risks.
CIBC’s bountiful 7.4% yield is more compelling than Royal Bank’s 5.2% yield. But given the potential for tremendous capital losses as a result of CIBC’s less-than-stellar mix of loans, I can’t recommend the stock at this juncture. I’d much rather go with Royal Bank here given it’s better-equipped to roll with the punches that are coming the way of the Canadian banks.
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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 Joey Frenette has no position in any of the stocks mentioned.