Bank of Nova Scotia’s BNS-T share price has underperformed its peers this year by a wide margin, raising the question of whether investors should embrace the upcoming leadership change at Canada’s third-largest bank.
The better approach: Worry less about changes in the C-suite and take a closer look at the stock’s compelling valuation.
On Monday, Scotiabank announced that Brian Porter, the bank’s chief executive officer, will step down from the position on Jan. 31. His replacement: Scott Thomson, currently CEO of Finning International Inc., the world’s largest dealer in Caterpillar equipment used in mining, forestry, agriculture and construction.
The change will likely draw attention to Scotiabank’s lagging performance.
This year, the share price is down nearly 25 per cent, making it the worst performer among the biggest six Canadian banks. On average, the Big Six are down 14 per cent in 2022.
Scotiabank’s longer-term performance looks equally dismal. The shares are down 10.2 per cent over the past three years, making it the only member of the Big Six in negative territory over this period.
That’s ugly, especially given that big banks – outside of major downturns – are often relied upon for steady returns that reflect economic activity.
The problem for Scotiabank in recent years is that the stock market has been less than enthusiastic about the bank’s significant exposure to emerging markets.
Scotiabank’s peers have stayed largely within Canada or expanded into the United States.
Bank of Montreal announced a deal to acquire San Francisco-based Bank of the West for US$16.3-billion in 2021; Toronto-Dominion Bank announced a US$1.3-billion deal to acquire New York-based investment bank Cowen Inc. this past August.
But Scotiabank in 2021 generated 18 per cent of its profit from the Pacific Alliance countries of Mexico, Peru, Chile and Colombia.
This large exposure has been a tough sell to investors who have witnessed the halting performance of emerging markets since BRICS – Brazil, Russia, India, China and South Africa – failed to live up to economic expectations in recent years.
The MSCI Emerging Market Index, which tracks stocks in 24 countries including China, India and Brazil, has produced an annualized gain of just 2.9 per cent over the past 10 years (to the end of August). The comparable figure for the S&P 500 Index is 9.7 per cent (to Sept. 23).
Bank of Nova Scotia has a more specific challenge with its exposure: While rising interest rates are supposed to add a significant tailwind to a bank’s loan profitability, Scotiabank has seen its international net interest margins – which compares interest it is making on loans to payments it is making on deposits – decline slightly.
“It appears that the bank is having difficulty managing interest rates in the Pacific Alliance,” Darko Mihelic, an analyst at RBC Dominion Securities, said in a note in August, after Scotiabank released its fiscal third-quarter financial results.
The decline was serious enough for Mr. Mihelic to trim his target price on the stock – or where he expects the share price to be within the next 12 months – to $83, from $94 previously. He also lowered his recommendation to “sector perform” from “outperform.”
Can new leadership make Scotiabank’s Pacific Alliance exposure a reason to embrace the stock?
Perhaps. But a better reason to take a closer look at the stock is its low valuation.
Its price-to-earnings ratio is the lowest among the Big Six, at just eight times estimated earnings, according to RBC Dominion Securities. That is the stock’s lowest valuation in 15 years and well below its average P/E of 11 over this period.
Another standout figure: The dividend yield is 5.9 per cent, the highest among peers and well above the sector average of 4.5 per cent.
A bet on Scotiabank hasn’t paid off in recent years. But the beaten-up share price and low valuation are hard to ignore.