Bank of Nova Scotia (TSX:BNS) has underperformed its peers in recent years. A new chief executive officer is planning to turn the business around, and contrarian investors are wondering if BNS stock is now oversold and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio focused on dividends and total returns.
Bank of Nova Scotia stock
BNS trades for close to $63 at the time of writing. This is actually up about 13% from the 2023 low, but still down about a third from the high the stock reached in early 2022 before the Bank of Canada and the U.S. Federal Reserve started to aggressively increase interest rates.
In normal economic conditions, the banks would typically benefit from rising interest rates because they can generate better net interest margins. However, in the past 18 months, the central banks have raised rates so much that investors have become increasingly concerned that the banks would be hit by a wave of loan defaults.
The Bank of Canada and the U.S. Federal Reserve are trying to get inflation down to 2%. This requires cooling off the economy. Driving up borrowing costs is the preferred way to slow consumer spending, but there is a risk that the rate hikes have been too quick and too large. It takes time for the increases in interest rates to work their way through the economy. Borrowers with variable-rate loans are impacted immediately, but households with fixed-rate mortgages don’t feel the pain until they have to renew.
Markets have worried that the economy could fall off a cliff rather than navigate a soft landing. If businesses are forced to cut staff in large numbers while households are still struggling with higher living costs and surging loan payments, there could be trouble on the horizon for the banks.
Bank of Nova Scotia and its peers have already increased their provisions for credit losses (PCL) to address the increase in troubled accounts, but the amount is still very small on a relative basis, and the overall loan portfolio remains in decent shape.
Ongoing volatility should be expected, but the market appears to be pricing in a much worse outcome than is predicted by economists.
Bank of Nova Scotia earnings
Bank of Nova Scotia expects earnings to be modestly higher in fiscal 2024 compared to this year. Adjusted net income came in at $8.44 billion in fiscal 2023. This was down from $10.75 billion in fiscal 2022.
The bank increased its common equity tier-one (CET1) capital ratio to 13% as of the end of October. The Canadian banks are required to have a CET1 ratio of at least 11.5%, so Bank of Nova Scotia is sitting on excess cash that will help it ride out any unexpected economic turbulence.
Bank of Nova Scotia reduced its headcount by about 3% in recent months and booked some heavy charges in the fiscal fourth quarter of 2023 to make sure it starts fiscal 2024 with a clean slate as it continues to work through its strategic changes. The company will focus new investment on its Canadian, U.S., and Mexican operations while looking for ways to reduce costs in the remaining international businesses, primarily located in Peru, Chile, and Colombia. Investors might even see the bank exit the three markets over the medium term if performance doesn’t improve.
Bank of Nova Scotia raised the dividend in 2023. Investors can currently get a 6.7% yield on the stock.
Is BNS stock undervalued?
It will take time for the strategic shift to bear fruit, but investors might want to start adding BNS stock to their portfolios while it is still out of favour. The upside potential is significant on a rebound, and investors get paid well to wait for the recovery.