Will 2017 be the year Canadian banks hit a ceiling?

Will 2017 be the year Canadian banks hit a ceiling?

Will 2017 be the year Canadian banks hit a ceiling?

2016 was another gravity-defying year for Canadian bank stocks, with the Big Six experiencing gains averaging more than 25%. But extracting further upside potential in 2017 may prove to be challenging, according to the Financial Post.

Citing Barclays analyst John Aiken, the report said that any additional gains will have to come from earnings growth rather than mere multiples expansion. “There was a significant change in the multiples that investors were willing to pay for Canadian bank earnings at the start of 2016 versus the start of 2017,” he said to clients.

All of the Big Six banks enjoyed multiple expansion last year; in addition, all of them (except for CIBC) are trading well above a multiple higher than they were a year ago. The analyst estimated that around 80% of share price gains for the sector came from multiple expansion, whereas changing earnings expectations only accounted for the remaining fifth.

Earnings expectations for 2017 are higher than they were a year ago, but they’re still meager at an average of 4.4%.

Upside from multiple expansion is likely to be exhausted: the market seems to be pricing in a sunnier outlook than what analysts are projecting, and given the strained economic situation in Canada, that outlook is predominantly US-centric. “Consequently, we believe that the valuation multiples accorded to the Canadian banks are stretched and are unlikely to see any material expansion at this point,” the analyst said.

Even though the multiples are well below historical peaks, Aiken noted that the changing regulatory environment and reduced profitability due to increased levels of required capital will make it difficult for the sector to replicate those records.

He also pointed out that the Big Six banks are trading at almost a full multiple above their long-term average in a tepid environment. He identified Bank of Montreal and Royal Bank of Canada as stocks with higher multiples but lower growth expectations.

“Admittedly, RBC and BMO do have large U.S. operations and could benefit from the higher rates and potentially lower tax rates, which are not likely currently factored into consensus estimates,” Aiken said. “However, if that is the case, we would expect Toronto-Dominion Bank to benefit as well, further advancing its own growth profile while still being priced at a lower valuation multiple.”

 

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