Thursday, April 26, 2007

RBC Investor Day

  
Financial Post, Duncan Mavin, 26 April 2007

Royal Bank of Canada’s investor day held on Wednesday was a hit with Desjardins Securities analyst Michael Goldberg.

“If the objective was to highlight Royal’s leading market share and scale advantages in Canadian banking and wealth management, then the day was a success,” Mr. Goldberg said.

Some of the most impressive statistics are in domestic banking and include: RBC has a 26% share of the market for current accounts — a 9.3% lead over Toronto-Dominion Bank; it has a 12% share of loans, which is 2.3% more than Bank of Montreal; 19% of small business banking is with RBC, which is a 3% lead over TD; and in commercial banking, RBC leads with 23%, 10% more than TD.

“The message,” said Mr. Goldberg, “Royal has market share leadership and greater ability to spend money and devote resources in support of further strengthening this franchise.”

The other theme of the investor day was to introduce RBC’s new wealth management group. Formed out of a recent rejigging of reporting lines, the group is headed by George Lewis and includes all of RBC’s wealth management units in Canada and abroad. The group is focused on serving “affluent” and “high net-worth” clientele, Mr. Goldberg said.

In both Canadian banking and wealth management, returns — ROE of 32-35% and 28-30% respectively — are high, the Desjardins analyst said.

Mr. Goldberg maintains his “buy” rating on RBC, and his $60 target price is unchanged.
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BMO Capital Markets, 26 April 2007

Valuation

We are raising our target P/E to 14.5x 2007E earnings to reflect our increased confidence in the new structure. By more finely segmenting the businesses under focused management, we believe that Royal can continue to drive earnings - at or above industry growth rates. Our target price increases to $62.

Recommendation

We continue to recommend RY shares. Given the premium ROE, the above average growth and the leadership market positions, it is tough not to recommend RY shares.

Details & Analysis

Royal Bank held an investor day yesterday to highlight its Canadian Banking and Wealth Management segments. The purpose of the presentations was to shed more light onto the business activities that, when combined, make up over 60% of the bank’s earnings (see chart).

The timing of the event coincided with Royal’s decision to re-segment its financial statements, breaking out a new Wealth Management segment from under the Canadian and U.S. & International Personal and Business Banking segments.

The new segment will include Global Asset Management, Canadian Wealth Management and U.S. & International Wealth Management (which includes Global Private Banking), and will be headed by George Lewis, who previously ran RBC’s Canadian Wealth Management business. Management emphasized that the new reporting method would not change the responsibility lines in the field, and that the level of integration between the banking and wealth management segments would remain high.

The overall tone of the presentations was positive. The Canadian Banking segment, which includes personal and business banking, cards and insurance, continues to lead the industry in product breadth, distribution, and market share. On the personal side, the bank is committed to boosting core deposits, with increased sales and processing efficiency efforts and continued roll-out of new products to fit its customer base and profit targets (such as the limited high-interest saving account). Business banking also looks well positioned and should be able to maintain, and possibly even improve, its industry-leading market shares.

The Wealth Management segment, under its new head, has produced excellent long-term results, with tremendous success in Canada and in Global Private Banking, and reasonable performance in the U.S. Note that the Wealth Management business, in total, has grown earnings at close to over 25% compounded over the past three years, and this trend continued into first quarter of 2007. The mutual fund business remains best in class and has led the Canadian industry for 13 consecutive quarters, driven by tremendous distribution, strong investment performance and a full suite of products. Despite its leadership position, the bank is prepared to be a disruptive force in the market with various price reductions and enhanced distributor commissions. RBC Dominion Securities continues to lead the industry in full-service brokerage in terms of assets per broker, overall assets and profitability. The contribution made by the U.S. & International Wealth business is largely the result of Global Private Banking, which appears to have successfully integrated various selective acquisitions. Results out of Dain Rauscher appear to remain modest due to high levels of competition in the U.S. marketplace, and a less robust competitive position. Management indicated that they remain open to acquisitions to bolster this business—both in the U.S. and in Europe.

On the whole, the day served to confirm our views that retail banking and wealth management are good businesses in which to compete, and that Royal is well positioned to match, or exceed, overall industry growth. We are raising our target price to $62, to reflect a P/E multiple of 14.5x our 2007 estimate. We maintain our Outperform rating on RY shares.
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TD Newcrest, 26 April 2007

Event

Yesterday, RBC hosted its 2007 investor day which focused on the domestic retail banking and wealth divisions. The bank also provided new disclosure to reflect new business segments: Canadian Banking, Wealth Management, U.S. and International Banking, and Capital Markets.

Impact

Neutral. The presentation reconfirmed our positive sentiment on the domestic retail and wealth management operations (see Exhibit 1 for detailed financial highlights). Our earlier estimates regarding the size of the domestic wealth operation were proven optimistic; however, we remain confident with our 12-month target of $67.00 and Action List Buy recommendation.

Details

Canadian Banking: Domestic retail banking contributed 54.1% to overall revenues in Q1/07 and close to 57% in 2006. Of note, the division’s operating leverage was an impressive 6.5% which we believe reflects the benefits of size and scale. We believe RBC is taking advantage of unmatched distribution capabilities (the bank operates the largest distribution network among financial services companies in Canada) to grab market share in key high margin businesses such as cards and business banking. We also note:

• RBC ranked first in consumer lending market share in 2006, surpassing other retailing giant TD. We believe a domestic duo-poly is being created in the Canadian market place, and the distance between RY and TD versus the competition will continue to widen. Perhaps the most important area in which the bank has rapidly grown share is the domestic cards business. While not providing a detailed financial breakout of this product, the bank offered the following information: 1) it is #2 in purchase volume market share (20%), and only trailing CIBC by 2%.

While obtaining third party market share data is impossible, we believe the bank’s growth in this area is remarkable. Significant credit was given to the bank’s advertising campaigns, which will remain constant. 2) Cards represent 14% of domestic banking revenues, but a greater share of profitability. Management added that cards earn better ROEs than the entire bank (27% last quarter), a clear demonstration that market share growth certainly has come at the expense of profitability.

• On the deposit front, strategies to grow deposits (introduction of a new high rate savings account, aggressive marketing campaigns, improved technology, and focus on lower cost e-banking) have led to significant inflows, according to management, of which 65% is new money. Management estimates that approximately 180,000 RY clients have accounts at ING Canada (which uses cheap sources of deposits to fund mortgage growth), and believes that it has come up with a competitive product to bring them back under the RBC umbrella, and we agree.

• Discount brokerage, which is still included in Canadian Banking results, is another focus for RBC. The bank’s internal research suggests that gradually more clients are using the discount brokerage services of their home bank, thus presenting it with an excellent cross selling opportunity. We believe RY could improve on existing products, services, and perhaps pricing in order to attract clients away from TD Waterhouse, by far the dominant player in the Canadian discount brokerage space.

Wealth Management: RY’s wealth operations generated $992 million in revenues last quarter and $217 million in profitability. While we acknowledge having been top heavy in our profitability estimate for the division, we remain unequivocally convinced by the size, growth, and future opportunities available to it. We note that management intends to grow revenues at 10% per annum while achieving 30% pre-tax margins, which is achievable in our opinion for the following reasons:

• Distribution: RBC owns the Canadian distribution network, with over 75% of sales of RBC mutual funds emanating from the Canadian Banking channels. In addition, the bank has forged relationships with over 8,700 investment advisors, which we believe provides the bank with healthy growth potential.

• The Domestic Mutual Fund Squeeze is on: There is no doubt that the bank intends on leveraging its scale to further grow its mutual fund business. A combination of strong performance, lower fees charged andstrong commissions will be key to future growth. We expect further announcements will come demonstrating that RY is serious about winning even more market share in this very profitable business.

• International Growth: We believe a key piece to generating sustainable revenue growth for the bank hinges on international expansion (generally a high ROE undertaking). Although acquisitions will be part of the strategy we get the feeling that product enhancement, organic growth, and recruitment (RBC added over 1,200 client facing professionals in 2006) will continue to be the focus.

Justification of Target Price

Our $67.00 target is a product of adding 50% of the $65.74 value derived from our 2008 P/E valuation of 14.3 times to 50% of the $68.02 value derived from our 2008 price-to-book valuation of 3.48 times.

Key Risks to Target Price

We believe the key risks are: 1) unfavorable interest rate movements; 2) a downturn in the credit cycle; and 3) additional US acquisitions at premium valuations.

Investment Conclusion

Yesterday’s investor day was an opportunity for RBC to showcase its dominant retail and wealth management operations, and we believe management did an excellent job. While we believe that the current retail banking environment has benefited all the Canadian banks, RBC is clearly exhibiting superior operating momentum and undoubtedly pulling away from the pack. The division is generating 30%+ ROEs while spending meaningfully on numerous initiatives which should produce “best-in class” revenue growth well into the future, in our opinion. We rate the stock an Action List Buy.
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Reuters, Lynne Olver, 25 April 2007

Royal Bank of Canada plans to ramp up international investment to win more of the lucrative wealth management business outside Canada, executives said on Wednesday.

"We view wealth management as a good global opportunity," President and Chief Executive Gord Nixon said during a presentation to analysts and investors.

Earlier this year, RBC, the country's largest bank, said it would rearrange its business lines for reporting purposes. Results for its new wealth management segment, one of four divisions, will appear in the bank's second-quarter results, due for release May 25.

"We believe that by creating the wealth management structure, it will give us the ability to be more focused in terms of driving wealth management investment and growth outside of Canada," Nixon said.

Previously, that international business had been part of RBC's U.S. and international banking unit.

The bank provided "resegmented" first-quarter financial results on Wednesday to help future comparisons. Overall net income for the first quarter ended Jan. 31 was unchanged at C$1.49 billion ($1.34 billion).

George Lewis, the bank's head of wealth management -- which includes global private banking, full-service brokerages in Canada and the United States, and money manager RBC Asset Management -- said that he plans "aggressive growth" in revenue and earnings outside Canada.

To meet the bank's goals, "acquisitions will definitely be a consideration," Lewis said at the investor event.

These could come via smaller, "bolt-on" acquisitions in global private banking, he said.

For example, RBC will continue to look at trust acquisitions in Britain to complement its Channel Islands offshore trust service, and would also consider international investment management additions, Lewis said.

In the United States, brokerage RBC Dain Rauscher Inc., based in Minneapolis, Minnesota, has been adding financial consultants, most recently with the March acquisition of retail brokerage J.B. Hanauer, which had 300 employees at offices in New Jersey, Pennsylvania and Florida.
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