National Bank’s candid approach pays dividends

David Parkinson

Sometimes, it pays to be candid.

National Bank of Canada and its shareholders have found that out over the past week, after a refreshingly open discussion in the bank’s post-earnings conference call lit a fire under the company’s stock. Company officials not only strongly hinted that a dividend increase was in the pipeline, but cleared much of the fog surrounding the likely impact of the impending Basel III global financial-sector reforms – thus substantially reducing two of the biggest uncertainties that have been hanging over not only National Bank’s shares, but all Canadian banking stocks.

The upshot? A small flurry of analyst upgrades and a 12-per-cent jump in the stock price in the space of a week. The stock closed Wednesday at $62.28, its highest close in nearly four months.

“The hint of a dividend increase sounds almost overt, and clearly shows [National Bank] has few reservations about Basel’s minimum hurdles for freedom on dividend payout ratios,” said Cormark Securities analyst Darko Mihelic, who upgraded the stock to “market perform” from “underperform” following the conference call.

The two issues are difficult to separate. It’s generally believed that the Office of the Superintendent of Financial Institutions – Canada’s banking regulator – wants to see the new Basel regulations on bank capital requirements in place before approving any new dividend increases from the Big Six Canadian banks, which includes National.

But with the new Basel rules expected by the end of November, and National Bank signalling its desire to raise its dividend, there’s speculation now that the bank could announce a payment increase before the end of the year.

“A dividend increase is possible as early as Dec. 2, when [National Bank] releases its fourth-quarter earnings,” wrote Scotia Capital analyst Kevin Choquette, who upgraded the stock to “sector outperform” from “sector perform” on Wednesday.

National Bank’s current dividend yield is just a shade under 4 per cent, in the middle of the pack among Canada’s Big Six banks. Yet analysts say that of all the Big Six, National Bank is in the best financial position to resume dividend increases sooner rather than later.

TD Newcrest analyst Jason Bilodeau said in a report this week that the bank’s dividend payout ratio (its dividends per share as a percentage of earnings per share) is just 40 per cent based on estimated 2010 earnings, and is set to fall to 37 per cent based on forecast 2011 earnings. Those numbers are not only easily the lowest of the Big Six banks, but are headed below National’s self-imposed dividend payout target of 40 to 50 per cent.

“We’re below our target, so I think it’s quite clear what our next step would be,” National Bank chief executive officer Louis Vachon said in last week’s earnings conference call, hinting that clarity from Basel and OSFI are the only obstacles to quickly raising the dividend. “To the extent that we have good visibility on the regulatory side, the priority will be on the dividend side.”

That could put National Bank well ahead of the other big banks on resuming dividend increases – which have been on hold throughout the group since the financial crisis hit in the fall of 2008. But even without an early dividend increase, National Bank looks attractive to many market watchers relative to its peers.

Scotia’s Mr. Choquette noted that while National has historically traded at a lower price-to-earnings valuation than the other big banks – its P/E has averaged 84 per cent of the group’s historical mean P/E over the past 12 years – it’s now trading even cheaper than this historical discount, with a P/E of only 80 per cent of the group average based on both trailing 12-month earnings and its forecast 2011 earnings.

“The bank’s valuation has been at a discount to the peer group in 2010 as it was less exposed to the credit recovery, it was more exposed to normalizing trading revenue, and retail revenue has been at the low end of the peer group,” wrote RBC Dominion Securities analyst André-Philippe Hardy, who also upgraded the stock to “outperform” from “sector perform” this week. “We are more positive on National Bank’s relative outlook for the next 12-24 months.”