Friday, August 29, 2008

National Bank Q3 2008 Earnings

  
TD Securities, 29 August 2008

Event

Yesterday, National reported core cash FD-EPS of C$1.52 vs TD at C$1.47 and consensus C$1.39.

Impact

National turned in a decent quarter in our view with some progress in P&C and help from Financial Markets. The operating trends are largely in line with what we view as our conservative expectations for 2009. The stock has been a top relative performer, but remains at an attractive relative valuation; Reiterate Buy.

Details

P&C banking balancing act. Key to the story in our view is management's ability to successfully implement its various strategic initiatives to accelerate the P&C banking business. This will require balancing expense growth against fairly modest top-line trends. The last few quarters have been reasonably successful and management remains optimistic on Q4. However, we are holding what we view as a conservative outlook for 2009 on the view that expenses will expand and are awaiting clearer signs that revenue efforts are gaining traction.

Credit trends holding in well. The bank has benefited from its domestic/regional focus on the credit front and to date has enjoyed fairly steady trends. Management feels very good about its corporate book with almost no watch items, and the retail/commercial book is seeing very manageable deterioration. In a worsening credit cycle, we believe National stands to benefit from its potentially cleaner credit picture.

Maintain By rating. The stock has been the second best performing bank in the group over the last 12-months in a weak tape for financials. As a result, the relative valuation discount has closed materially (moving from - 2.4x to -1.6x on a fwd PE basis), but remains wide relative to its historical relationship (Exhibit 1).

P&C Banking. The results were decent in our view with NI +2% on the year. The quarter was lifted by positive operating leverage with expenses down approximately 3%. Management suggested additional investment in 2009, but will be closely monitoring expense levels relative to revenue growth. The segment also saw decent volume growth, with personal loans +7%, personal deposits +6%, commercial loans +6% and commercial deposits +10%.

Financial Markets. Q3 saw good results from Financial Markets with NI up 14%. Despite volatile markets, the quarter was driven by stronger trading revenues in fixed income and commodity/foreign exchange and mostly client driven equity trading revenues. NI growth was also helped by lower variable compensation costs.

Outlook

We have updated our full year estimate to C$5.80 (up from C$5.72) to reflect the beat on the quarter. We have not changed our 2009 estimate of C$6.00.

Justification of Target Price

We believe National Bank deserves to trade at a discount to the group, reflecting slower growth in its core operating trends and its geographic concentration. We base our target price on 10.5x forward earnings, a discount to our outlook for the group.

Key Risks to Target Price

These include: 1) substantial ABCP losses, 2) weakening economic conditions in Quebec, 3) the inability to compete on scale and flexibility, 4) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

In our view, the key to this story is management’s ability to drive growth in their P&C banking platform. Q3 posted a decent round of results, with underlying business trends in line with our arguably conservative expectations for 2009. Reiterate Buy.
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