'It's been lagging on performance this year': Pelletier on Scotiabank

Key Concepts

Scotia Bank Earnings: Analysis of Scotia Bank's recent financial performance.
Analyst Expectations: Comparison of actual earnings against predictions.
Revenue Growth: Year-over-year increase in total income.
Net Interest Income: Profit from lending activities.
Non-Interest Income: Revenue from fees, commissions, and other services.
Market Strength: Overall positive performance of the broader stock market.
Trading, Business Banking, Wealth Management: Key revenue-generating segments for banks.
Mutual Fund and Brokerage Revenues: Income from investment products and services.
IBanking: Investment banking activities.
Retail Banking: Consumer-focused banking services.
Valuations: Assessment of stock prices relative to earnings.
Forward Earnings: Projected earnings for the next fiscal year.
Longer Term Averages: Historical valuation metrics.
Dividend Yields: Annual dividend payment as a percentage of the stock price.
Provisions for Credit Loss: Funds set aside to cover potential loan defaults.
Restructuring Charges: One-time costs associated with internal changes.
Performance Gap: Difference in stock performance between peers.
Canadian Economy: The overall health and outlook of the Canadian economic landscape.
Bank of Canada: Canada's central bank.
Interest Rates: The cost of borrowing money.
Federal Reserve: The central bank of the United States.
Currency: The value of one country's money in relation to another.
Retail Lending: Loans provided to individual consumers.
Basket of Names: Investing in a group of similar stocks.
Covered Calls: An options strategy that generates income.
ETF (Exchange Traded Fund): A type of investment fund traded on stock exchanges.
Global Asset Management: Investment management services for global clients.
Enbridge: A North American energy infrastructure company.
Telus: A Canadian telecommunications company.
Tax Loss Selling: Selling investments at a loss to offset capital gains.
Dividend Cut: A reduction in dividend payments.
DRIP (Dividend Reinvestment Plan): A plan that allows shareholders to reinvest dividends to purchase more shares.

Scotia Bank Earnings Analysis

Martin Pelchce, Senior Portfolio Manager at Wellington Altus Private Council, provided an initial positive reaction to Scotia Bank's earnings, describing them as "fantastic" and noting that the bank "delivered a strong quarter beat analyst expectations despite onetime restructuring charges."

Key Financial Highlights

Earnings: Came in "quite strong."
Revenue: Up 15% year-over-year.
Net Interest Income: Showed a "nice increase."
Non-Interest Income: Also experienced a "nice increase."
Provisions for Credit Loss: No surprises, trend looked "okay."

Pelchce stated there was "really nothing to complain about" regarding the reported numbers.

Investor Outlook and Market Dynamics

The discussion shifted to how these results position Scotia Bank for investors and the broader market outlook for Canadian banks.

Broader Market Influence

The strength of the banks is currently being driven by "continued broader market strength." Key contributing factors include:

Robust Trading: Strong performance in trading activities.
Business Banking: Healthy growth in services for businesses.
Wealth Management: Significant contributions from this sector.
Mutual Fund and Brokerage Revenues: Strong revenues from investment products.
IBanking Trading Revenues: Positive performance from investment banking.

Conversely, "retail not so much. It's been okay." This suggests that banks with a larger focus on wealth management and investment banking are likely to continue performing well.

Valuation Concerns

A significant question for investors is whether current bank valuations are justified.

Current Trading Multiple: Banks are trading at 13 times forward earnings.
Historical Comparison: This multiple is "about a 25% above their longer term averages."

Pelchce highlighted that for investors to see continued returns, banks will need to "continue to deliver on that growth" because "dividend yields aren't as strong as certainly as they were at the beginning of the year." This growth will depend on the "broader market continuing to show that strength in 2026."

Scotia Bank's Internal Changes and Performance

The conversation addressed Scotia Bank's internal restructuring and its impact on its performance relative to peers.

Progress on Overhaul

Pelchce acknowledged that Scotia Bank is "doing some changes internally and they're making progress there." The hope is that these changes "can narrow the gap between it and the other banks."

Performance Lagging Peers

Scotia Bank has been "lagging on performance this year." Specific figures cited include:

Scotia Bank: Up 26% year-to-date.
CIBC: Up 37% year-to-date.
TD: Up 50% year-to-date.

This indicates "stock picking differences" in performance among these institutions. Pelchce believes Scotia Bank is "certainly making the right necessary changes to to narrow that gap."

Investment Strategy and Peer Comparison

While Pelchce's firm does not directly own Scotia Bank, they "own more of the basket of of the names," leaning towards TD and Royal Bank. Despite Royal Bank not performing as well this year, TD's strong performance offsets this.

A report from Jefferies questioned, "Are these things priced to perfection?" This sentiment underscores the ongoing concern about whether the current strong performance of banks is sustainable. The key questions remain:

Will Scotia Bank's changes "continue to generate the narrowing of its performance gap to its peers?"
Will the peers "continue to show some strength?"

Canadian Economic Outlook and Potential Rate Cuts

The discussion touched upon the broader Canadian economic landscape and the potential for further interest rate adjustments.

Retail Banking Risks

Pelchce anticipates potential weakness in the "retail banking side" due to the "broader Canadian economy is not on a sound footing."

Bank of Canada and Federal Reserve Actions

The Bank of Canada is commended for being "proactive in cutting interest rates," doing "a lot more so than than the Federal Reserve."
There is hope for a Federal Reserve rate cut, which could "ease some pressure on the Bank of Canada in regards to the currency" and prevent it from falling too far.

Exposure to Retail Lending

Banks with "greater exposure to retail lending and retail banking within Canada" are seen as facing "risk for the Canadian economy next year" and are likely to "exhibit some weakness." This weakness, it is hoped, can be "made up through continued growth in in the other segments."

Recommended Stocks for Investors

Pelchce shared specific stock recommendations for clients to consider.

Bank of Montreal (BMO) and BMO ETF (ZWB)

Sector View: Pelchce likes "the banks as a basket" heading into the new year but suggests "trimming some of that back or looking covered calls on some good some on these banks."
Bank of Montreal (BMO): Specifically, he likes BMO's "wealth management division. global asset management. Outstanding department run by some really good people over there." He notes the "growth that they've had within their wealth management side on the asset management division."
BMO Covered Call ETF (ZWB): This ETF is a "cover call on the basket of names" and is "yielding a 6%," providing an "extra dividend boost from the cover call space." Pelchce recommends it as a "good one to own" if continuing to hold bank stocks. He reiterates the idea of "trimming back some of the bank positions and going into some other segments in the Canadian market next year."

Enbridge

Performance: Enbridge is "only up 11% this year."
Characteristics: Described as "kind of boring" with a "nice dividend yield, you know, 5.6%."
Growth: Expected to have "a little bit of growth, maybe 3% growth."
Overall Return: Pelchce believes that if one can "bang out 10% a year on an Enbridge," combined with its dividend yield and considering current GIC rates, it's a "good stock to own." His firm "do[es] own it."

Telus

Acquisition Strategy: Pelchce's firm has been "buying Telus on the tax loss selling here."
Price: Currently trading around "$18."
Performance: Down 8% this year.
Dividend Yield: "Over 9%."
Dividend Cut Concerns: Addresses concerns about a potential dividend cut, similar to BCE, but notes that "as long as that drip continues to pay out that that really nice juicy 9%."
Outlook: Expects a "nice recovery following this tax law selling season here." The firm has been "buying a little bit of that on the on the dip."

Conclusion

Martin Pelchce's analysis of Scotia Bank's earnings reveals a strong quarter that beat expectations, driven by revenue growth in key segments like net interest and non-interest income. However, the broader market context is crucial, with bank valuations appearing elevated compared to historical averages. Investors are looking for continued growth to justify these valuations, as dividend yields are less attractive than earlier in the year. Scotia Bank is undergoing internal changes to narrow its performance gap with peers like TD and CIBC, which have seen stronger year-to-date gains. The Canadian economic outlook presents some risks, particularly in retail banking, prompting a cautious approach. Pelchce recommends a diversified strategy, suggesting a basket approach to banks with a focus on covered call ETFs like BMO ZWB, alongside investments in stable dividend payers like Enbridge and potentially undervalued telecommunications companies like Telus, which are being bought on dips.