Royal Bank of Canada: Simply better than most (NYSE: RY)

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Investment thesis

Royal Bank of Canada (NYSE:RY) is the largest bank in Canada by market capitalization and has been a solid investment for over 100 years. They have grown alongside the North American economy and have paid strong dividends to shareholders along the way. Thanks to strong fundamentals, the Royal Bank of Canada is considered one of the safest banks in North America (by Global Finance). During tumultuous times like these, Royal Bank of Canada is a great company to grow your money because:

  • They had a strong 2021 and their return on equity exceeded their pre-pandemic level.
  • They will benefit from a tailwind from the strong economy and are also well positioned to benefit from a rising interest rate environment.
  • Royal Bank of Canada has a very strong balance sheet and is fundamentally sound. It is one of the safest banks in North America.

Solid 2021 result

The Royal Bank of Canada posted a fairly solid 4Q 2021 and full year 2021. All of their segments (Personal and Commercial Banking, Wealth Management, Insurance, Investor & Treasury Services, Capital Markets, and Business Support) grew significantly from 2020. More importantly, their ROI exceeded its pre-pandemic level, which was great to see because it’s one of the most important performance indicators for a bank.

Return on equity trend

Return on equity trend (Royal Bank of Canada Investor Relations)

Calculation of ROE by segment

Calculation of ROE by segment (Royal Bank of Canada Investor Relations)

As a shareholder of the Royal Bank of Canada, this solid performance is a pleasure to see, but at the same time, it is not a surprise. They have been a superb investment for over 100 years at this point. Royal Bank of Canada’s total shareholder return has exceeded that of its peers for the past 20 years and, given their financial situation, I expect it to do so for the next 20 years.

Throughout their long history, they have paid a solid dividend (current yield of 3.09%) to their shareholders. With restrictions on increasing dividends and share buybacks lifted, experts expect Canadian banks to significantly increase their dividend and share buyback program over the next few years. In fact, Royal Bank of Canada has already announced its intention to repurchase 45 million common shares and increase the dividend by 11%. I expect the trend to continue for the foreseeable future.

Overall financial performance

Overall financial performance (Royal Bank of Canada Investor Relations)

The Tailwinds of a Strong Economy and Rising Interest Rates

The Canadian and US economies are recovering at a rapid pace (GDP growth well above 5% for both countries), which will provide tailwinds for financial institutions in general. Given its leadership position in Canada, Royal Bank of Canada will certainly benefit from strong economic activity, high levels of business transactions and an increased level of consumer liquidity.

As we all know, inflation is at its peak and the Canadian and US central banks are expected to respond by raising interest rates. On the earnings call, executives said they were in a good position to take advantage of rising interest rates. Thanks to their major deposit-freehold in Canada and the asset-sensitive nature of the U.S. wealth management balance sheet, a 25 basis point increase in interest rates across the curve will result in higher revenue from $165 million in Canadian Banking and US$85 million in US Wealth Management. A 100 basis point increase will result in an overall revenue increase of $929 million. Therefore, rising interest rates are good news for Royal Bank of Canada and its shareholders.

Interest rate increase chart

Rising interest rate environment (Royal Bank of Canada Investor Relations)

Solid balance sheet and fundamentals

Royal Bank of Canada has a very strong balance sheet and fundamentals. They have total cash of over $553 billion with total debt of $303 billion, resulting in net debt of negative $249 billion. Unsurprisingly, their leverage ratio (4.9%) and liquidity coverage ratio (123%) are also very strong. Their credit rating is among the highest in the world by Moody’s S&P, DBRS and Fitch, and the outlook is stable at this point.

Solid financial profile

Solid financial profile (Royal Bank of Canada Investor Relations)

Reflecting this balance sheet and strong fundamentals, Global Finance ranked Royal Bank of Canada as one of the safest banks in North America for 2021. It was number 1 in 2020, then traded places with Toronto-Dominion . (NYSE:TD) in 2021 (Number 2 in 2020). If you invest your money in Royal Bank of Canada, it is literally in the safest of hands.

The Safest Banks in North America

Safest Banks in North America 2021 (Global Finance)

Fair value estimate

At a P/E of 12.8x, shares of Royal Bank of Canada are trading at a premium of around 13% to the sector median. Given their strong fundamentals, safety and high yields, I think this premium is more than justified. Plus, they’re trading at a slight discount to rival Toronto-Dominion (P/E at 13.3x), further justifying the premium.

Given the favorable economic environment, easing regulations and the upcoming interest rate hike, I expect Royal Bank of Canada to outperform the broader market. In addition, they should continue to increase the dividend (10-15% per year) over the next few years and repurchase common stock to restore shareholder value. This will translate nicely into share price appreciation as well as a strong dividend yield of around 3-4%.

Risk

As a financial institution, Royal Bank of Canada’s share price reflects the economic strength of Canada and North America. Greater economic activity leads to more consumer-to-business transactions and cash, which leads to profits. Therefore, if the combination of inflation, labor shortages and supply chain disruption were to cause an economic slowdown, it would have a negative impact on Royal Bank of Canada. However, many economic indicators (GDP growth, employment growth, etc.) point to a very strong economy ahead of us. Additionally, I expect the interest rate hikes by the US and Canadian central banks and the shutdown of the stimulus package late last year to start showing an effect later this year. to calm inflation while stimulating the economy.

Many large US banks have reported increased spending due to wage inflation, leading to reduced profit margins. Wage inflation can also affect Royal Bank of Canada’s earnings. However, this margin squeeze is a short-term impact compared to their long track record of success and superb future prospects. I expect them to handle increased spending very well, and it won’t impact their long-term growth trajectory.

Conclusion

Royal Bank of Canada has been an excellent investment choice for a long time. They had a rock-solid 2021 and their ROE surpassed their pre-pandemic level, having fallen to 14% in 2020. They maintain a strong balance sheet and fundamentals, and Global Finance ranked them as the one of the safest banks in North America. . The good economic outlook and rising interest rates should benefit the financial sector in general, and the Royal Bank of Canada is in an excellent position to take advantage of these tailwinds. Potential stagflation due to high inflation, labor shortages and supply chain disruption may present challenges, but I believe they will manage them well as they have over the past of the last 100 years. I expect stock appreciation of 10-15% as well as a good dividend yield of 3-4%.

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