Bank of Nova Scotia (TSX: BNS) is up 15% from the 12-month low it hit in late October last year. A recent dip has investors who missed the rally wondering if the latest pullback is a good entry point or if more downside is on the way.
Bank of Nova Scotia stock
Bank of Nova Scotia trades near $64 per share at the time of writing compared to $55 about seven months ago. The stock actually hit $70 in late March and has since pulled back. During the post-crash rally, the stock rose as high as $93 in early 2022, so there is decent upside potential.
The drop that occurred through 2022 and most of 2023 can be broadly attributed to the impact of hikes in interest rates in Canada and the United States. High inflation caused by a roaring economy, a tight jobs market, and global supply issues forced the Bank of Canada and the U.S. Federal Reserve to aggressively raise interest rates to try to slow down the surge in demand for goods and services and bring the jobs market into balance. Inflation hit 9% in the U.S. in June 2022 and 8% in Canada.
Rate hikes take time to work through the system, but the strategy appears to be working. Inflation in April 2024 came in at 3.4% in the United States and 2.7% in Canada. Anticipation of rate cuts in 2024 to head off a recession largely drove the rally in bank stocks that occurred from early November 2023 to the end of March this year.
Risks
Inflation, however, is still above the 2% target and there are concerns that inflation could remain sticky around the 3% level. This is probably why the banks are giving back some gains.
Higher interest rates are normally good for banks due to the opportunity they provide to book higher net interest margins. The concern for investors is that businesses and households with too much debt are finding it difficult to cover the increase in their borrowing costs. Bank of Nova Scotia set aside about $1 billion in the latest quarter to cover potential bad loans. This is up from $709 million in the same period last year.
The provision for credit losses (PCL) is still small compared to the overall loan book, but the longer that rates remain elevated, the more likely it is that the banks could see a wave of defaults. The worst-case scenario would be one where the central banks are forced to keep rates elevated to fight persistent inflation, even as unemployment surges and the economy weakens.
Earnings
Bank of Nova Scotia reported adjusted net income of $2.11 billion in the fiscal second quarter (Q2) of 2024. That’s down slightly from $2.16 billion in the same period last year. For the first half of fiscal 2024, adjusted net income was $4.32 billion compared to $4.51 billion. Adjusted return on equity dipped to 11.3% from 12.3% in fiscal Q2 2023, but this is still a good result. Bank of Nova Scotia’s common equity tier-one (CET1) ratio, which measures the capital the company has on hand to help it ride out a financial crisis, was 13.2% compared to 12.3% in Q2 2023. The Canadian bank regulator currently requires a minimum CET1 ratio of 11.5%, so Bank of Nova Scotia is sitting on a large capital position.
Dividends
Bank of Nova Scotia increased the dividend in 2023. Investors who buy the stock at the current level can get a 6.6% dividend yield. At the very least, the distribution should be safe.
Should you buy BNS stock now?
Volatility in bank stocks should be expected in the coming months. A broad-based pullback in the equity market is likely after the big run to start the year and ongoing uncertainty regarding the timing and extent of rate cuts could continue to be a headwind.
That being said, Bank of Nova Scotia remains very profitable and has the capital to ride out some economic turbulence. If you have a buy-and-hold strategy and are looking for a high-yield pick for your portfolio, this stock is probably undervalued and deserves to be on your radar right now. Any additional downside would be an opportunity to add to the position to boost the average yield.
