Monday, May 07, 2007

RBC CM: CIBC & TD Bank Should Outperform BMO

  
RBC Capital Markets, 7 May 2007

CIBC and TD's Shares Should Outperform BMO's

• Both TD and CIBC trade at a lower 2008E P/E multiple than Bank of Montreal and should grow their earnings more rapidly.

• CIBC and TD should also grow dividends more rapidly given the higher expected EPS growth and increases in their dividends.

• We believe that those two banks have established themselves as the most conservative banks in Canada with less downside risk, a position we would have previously associated with Bank of Montreal.

EPS Growth Should be Higher at CIBC and TD

• We believe cost containment, improved retail revenue growth and the First Caribbean acquisition should drive CIBC's EPS increase. Our 2007 EPS estimate of $8.20 represents growth of 19%, the highest in the Canadian bank group, and is 3% or $0.25 ahead of the current consensus estimate of $7.95. We also believe that CIBC's earnings could be revised upward (by us and the Street).

• Domestic retail growth and higher earnings from the U.S. should buoy earnings growth for TD. We believe that TD can grow 2007 and 2008 earnings per share by 14% and 12%, respectively, representing median expected growth in 2007 and ahead of the 8% growth we expect for the bank's five Canadian peers in 2008. We also believe that there is less downside risk to our forecast for TD than for the industry.

• Bank of Montreal's earnings growth is likely to lag the group on more rapid increases in loan losses, a reduced outlook for trading revenue and unusually high earnings from the corporate segment in 2006. Our 2007 core cash EPS estimate of $5.40 versus consensus of $5.44 represents growth of 6% versus 2006 and is slightly below management's guidance of $5.45 to $5.70.
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Bloomberg, Doug Alexander, 7 May 2007

Bank of Montreal Chief Executive Officer William Downe has announced the biggest trading loss ever in Canada, unveiled 1,000 job cuts and missed a chance to expand in Chicago since taking the job two months ago.

And it may get worse. Analysts are lowering their profit estimates after Canada's fourth-largest bank reported pretax losses from natural-gas trades of C$350 million ($316 million) to C$450 million and said there may be more bad news to come. The slowing U.S. economy also will make it harder for Downe to meet his goal of increasing the Toronto-based company's profit by as much as 10 percent in the fiscal year that ends in October.

``It's been an unhappy start,'' said Brad Smith, a Toronto- based analyst at Blackmont Capital, who has a ``hold'' rating on Bank of Montreal shares. The trading losses ``coming out of the blue can only make things more difficult and challenging.''

Bank of Montreal probably will report on May 23 that fiscal second-quarter profit fell to C$1.10 a share, from C$1.24 a year earlier, according to the average estimate of seven analysts surveyed by Bloomberg. At least three analysts reduced their earnings estimates in the past week.

Profits were falling before the April 27 announcement of the trading loss. Net income dropped 3.5 percent in the first quarter to C$585 million, after C$88 million of costs to eliminate jobs, the biggest round of firings for a Canadian bank in three years.

``The trading losses are another black eye,'' said Steve Cawley, a Toronto-based analyst at TD Newcrest, who has a ``hold'' rating on the stock. ``We struggle to find a growth catalyst.''

Spokesman Ralph Marranca said executives declined to comment on the trading loss.

Bank of Montreal shares fell 4.1 percent since the trading loss was unveiled and are down less than 1 percent this year, compared with a 2 percent gain in the Standard & Poor's/TSX Banks Index. The stock fell 28 cents to C$68.37 in 4:10 p.m. trading today on the Toronto Stock Exchange.

Downe, 55, has spent 24 years with the bank. The Montreal native started as a credit analyst in 1983, five years after he received a master's degree in business from the University of Toronto.

Downe took assignments in Houston and Denver before working in Chicago for about 14 years. In 2001, he became head of the BMO Nesbitt Burns investment-banking arm. A year later, he was charged with overseeing all U.S. operations, including Chicago- based Harris Bank.

``Creating growth opportunities in the U.S. is really important to our company,'' Downe said in an April 2003 interview. He was promoted to chief operating officer in February 2006, a post he held until succeeding Anthony Comper as CEO on March 1.

Bank of Montreal ramped up natural gas trading in the second half of 2005, buying and selling gas futures contracts and options when clients wanted to trade.

The trading losses may lead Downe to curb bets, said Jim Hall, who helps oversee C$4.7 billion at Mawer Investment Management Ltd. in Calgary and holds Bank of Montreal shares.

``It will be very difficult for him to pursue a higher-risk strategy,'' Hall said. ``He's having his knuckles rapped, and there isn't anything he can do other than be a very low-risk operation for the next little while.''

Trading revenue probably will total C$178 million this year, down from an earlier forecast of C$688 million, Desjardins Securities Inc. analyst Michael Goldberg wrote in a May 1 report to clients. Goldberg cut his per-share profit estimate for Bank of Montreal by 65 cents, or 13 percent, to C$4.50 for the fiscal year ending Oct. 31. That compares with profit of C$5.15 a share in 2006.

Downe also may struggle to increase profit in the U.S., where the economy expanded at a 1.3 percent pace last quarter, the slowest in four years. Profit at the company's Harris Bank unit in Chicago has been little changed because of rising costs from acquisitions and adding branches. Earnings fell 14 percent in the first quarter as expenses rose.

The bank plans to slow its branch expansion in the U.S. to about three to five branches a year, from six to eight.

``We'll pick that back up when we see a pickup in the economy,'' Downe told reporters following the annual meeting of shareholders on March 1.

Bank of Montreal lost out on the takeover of LaSalle Bank, Chicago's largest lender, after ABN Amro Holding NV agreed to sell the company to Bank of America Corp. for $21 billion. The offer for LaSalle is equal to about two-thirds of Bank of Montreal's market value. A Dutch court last week blocked the sale by Amsterdam-based ABN Amro and said it was unacceptable without seeking shareholder approval.

Takeovers in the Midwest, particularly around Chicago, ``leads us to believe BMO will succumb to pressure to either take out a local competitor or divest Harris,'' Citigroup analyst Shannon Cowherd said in a May 2 research note.

Cowherd says selling Harris is ``a very attractive option'' and Bank of Montreal may get as much as $9.9 billion for the U.S. unit.

Bank of Montreal ``clearly expressed interest in owning the Chicago-based assets of LaSalle, however Bank of America's offer appears to put these assets beyond their reach,'' UBS Canada analyst Jason Bilodeau wrote in an April 23 report to clients.

It's too early to blame Downe after just two months, said Stephen Jarislowksy of Montreal-based Jarislowsky Fraser Ltd., who owns shares of Bank of Montreal among the C$63.6 billion that he helps oversee for clients.

``The buck stops with the chief executive, but that doesn't mean that there's not a hell of a lot of things being done below him,'' Jarislowsky said. ``He can't possibly know everybody in the company."
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