New Purchase: Royal Bank

 

Things move so fast recently that I completely forgot to update you on my most recent purchases! In January, I bought shares of 4 different dividend growth companies. I already mentioned my purchases of MMM and EMA.TO. This means I have two more companies to tell you about!

During the same month, I decided to add a Canadian bank to my children’s tuition fund (RESP) portfolio. Since I will not need this money for another 10 years, I thought it was a good time to add one of those dividend growth marvels that are Canadian banks. Last year, I reviewed the Big 5 and wrote that my favorite was Royal Bank (RY.TO). I then decided to put my money where my mouth is and pull the trigger.

I purchased 29 shares of Royal Bank (RY.TO)

Investment Thesis

RBC has been on my Dividend Stocks Rock Buy List since July 2015. This is a very selective list of only 5 US and 5 Canadian dividend growth stocks. I consider RY as a very interesting play as its capital market and wealth management sectors provide strong and consistent revenue streams alongside their traditional banking. They do an awesome job generating strong profits from capital markets and their wealth management division generates revenues from over 15 million clients. They recently purchased City National, a private & commercial bank for wealthy clients based in Los Angeles.

While the Canadian debt ratio is still a concern, RY diversifies its revenue sources away from mortgages and commercial loans. However, keep in mind that capital markets brings higher volatility.

Most recently, Royal Bank continues to please their investors with solid results. While the market keeps worrying about the effect of low oil prices on RBC assets & loans, the largest Canadian bank in terms of market capitalisation is piling up good results with a record year for personal and commercial banking segment results.

The wealth management division also recorded solid growth despite the bearish Canadian stock market. Unfortunately, it was a tougher quarter for the capital markets segment that missed analysts’ estimates.

In a global picture, Canada’s economy is currently neither in good nor bad shape. While we have problems related to oil prices, we also have stronger sectors benefiting from the low CAD. Commercial loans are currently increasing and have offset and customer retail loan slow downs.

70% of RBC revenue is derived from its capital market and banking activities. While the regular banking has stagnated, capital markets are doing well. Another 12% of its revenue comes from its wealth management services. We believe this is a growth sector for the years to come and RBC is playing its cards to remain a leader in this niche.

Another interesting point is that RBC is not highly exposed to the energy industry. Its loan portfolio contains only a 1.6% exposure.

Its most recent drop in stock price in January leads to a dividend yield over 4.50%. This is a remarkable opportunity for any income seeking investor. This is when I purchased RY.TO.

Risk

While the Canadian debt ratio is still a concern, RY diversifies its revenue sources away from mortgages and commercial loans. However, keep in mind that capital markets business does bring higher volatility. If oil remains this low, it will also hurt RY’s stock price for 2016. It’s a good moment to buy Canadian banks, but you will have to be patient. Therefore, it’s a perfect fit for my portfolio!

Valuation

A simple look at the past 5 year PE ratio can tell you a lot about how Royal Bank is being benched by the market lately:

The stock has never traded at such low valuations since 2011. They say to buy when there is blood on the street, huh? Well I think we have hit this point with Canadian banks!

In order to be very sure of my purchase, I also use a double stage dividend discount model. After all, what really matters for me is the value of a company considering how much it will pay me back in dividends in the future. I didn’t go crazy with the dividend increase rate with a 6% growth rate for the first 10 years and I dropped it to 5% afterward. Here’s what my calculations look like:

Input Descriptions for 15-Cell Matrix	INPUTS
Enter Recent Annual Dividend Payment:	$3.16
Enter Expected Dividend Growth Rate Years 1-10:	6.00%
Enter Expected Terminal Dividend Growth Rate:	5.00%
Enter Discount Rate:	9.00%

Calculated Intrinsic Value OUTPUT 15-Cell Matrix
	Discount Rate (Horizontal)
Margin of Safety	8.00%	9.00%	10.00%
20% Premium	$144.36	$107.93	$86.09
10% Premium	$132.33	$98.93	$78.91
Intrinsic Value	$120.30	$89.94	$71.74
10% Discount	$108.27	$80.95	$64.57
20% Discount	$96.24	$71.95	$57.39

Source: Dividend Monk Calculation Spreadsheet

With an intrinsic value of $89.94, I can’t really go wrong with a purchase at $69.75 (back in January 2016). The company could easily jump by 20% in the upcoming year if the cloud over the Canada’s economy would clear.

While this may seems like wishful thinking, the latest confirmation that many oil producing countries are considering a cap on production growth to increase prices leads me to believe we are about to enter a better era. In addition to this, I’m also expecting some good news from the next Federal Government budget where Liberals promised over 10 billion per year invested in infrastructure. This should help the Canadian economy and give some room to Canadian banks. Overall, I’m convinced that Royal Bank will continue to increase its dividend and its stock price will definitely go up in value.

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