This Canadian Bank Looks Unstoppable

On Tuesday, Royal Bank of Canada (RY) announced that it had won the competition between Canada’s Big Six banks to buy the Canadian business of HSBC Holdings (HSBC) for CAD13.5 billion ($10.0 billion).  

A day later, Royal Bank reported its fourth quarter and 2022 results. While the report could best be described as steady, if it successfully convinces regulators that it’s the best home for HSBC’s Canadian assets, it will become Canada’s undisputed banking leader. 

While the purchase isn’t a slam dunk, should it be completed as planned in late 2023, investors would be hard-pressed to find a better Canadian bank stock to own.

Here’s why.

Royal Bank Is Immensely Profitable 

Despite a 2% decrease in the bank’s net income in fiscal 2022 (Oct. 31 year-end), it still managed to generate CAD15.8 billion ($11.7 billion) in net income from CAD49.0 billion ($36.2 billion) in total revenue, good for a 32.2% net margin. 

That’s the kind of margin grocery stores would kill for. 

What else is worth pointing out about Royal Bank’s latest fiscal year? I can think of several things. 

If dividends and share repurchases are your thing, the bank returned CAD$12.4 billion to its shareholders in 2022, 56% in the form of dividends, and 44% through share repurchases. 

Over the past eight years, the bank has grown its dividends by 7% annually on a compounded basis, while its share price has achieved 6% annual growth, good for a total shareholder return of 13% since Katie Taylor became Chair of the Board in 2014. 

As part of its Q4 2022 press release, Royal Bank announced it would increase its quarterly dividend by 3% to CAD$1.32 a share ($0.97). That’s a very healthy 4.0% dividend yield. 

If you’re looking for a bank with size and scale, Royal Bank’s got it. 

CEO Dave McKay stated in his opening comments of the bank’s 2022 annual report:  

“... [W]e ended the fiscal year as a top-10 global bank by market capitalization and the highest valued bank on a Price-to-Book Ratio among global banks. We’ve also been recognized yet again as the most valuable brand in Canada and second among all global banks.”

The acquisition of HSBC Canada will make it that much larger in the Canadian marketplace. That’s a win for shareholders. 

What Royal Bank Gets With HSBC Canada

Canada is one of the most pro-immigration countries in the world. Over the next three years, it will welcome 1.45 million people as part of the country’s Immigration Levels Plan. By acquiring HSBC Canada, it positions Royal Bank as the “bank of choice for newcomers.” 

It also provides the bank with the tools to properly service commercial customers with international needs and affluent clients who require global banking solutions. 

HSBC Canada has operated in Canada since 1981. In that time, it’s grown its business to CAD$134 billion ($98.9 billion) in assets, CAD$82 billion ($60.5 billion) in deposits, and a loan portfolio of CAD$76 billion ($56.1 billion). 

The bank has more than 12,000 commercial customers and 770,000 retail clients. It’s won awards for being the best small business bank in Canada. It has an opportunity to grow the number of products and services that current HSBC Canada customers use.  

From a profitability standpoint, Royal Bank expects HSBC Canada to generate CAD$1.4 billion ($960 million) in net income after tax by 2024, thanks partly to CAD$740 million in found expense synergies ($546.3 million).

“This acquisition builds on our core domestic retail business and expands our international product capabilities,” said Neil McLaughlin, Group Head, Personal & Commercial Banking, RBC.   

The transaction will face regulatory scrutiny from the OSFI (Office of the Superintendent of Financial Institutions), the federal Competition Bureau of Canada, and the federal Minister of Finance. Of the three, the Competition Bureau is the biggest stumbling block. 

However, HSBC Canada only accounts for 2% of Canadian deposits and mortgages. The acquisition might make Royal Bank bigger -- it would have more assets than Toronto-Dominion Bank, Canada’s second-largest bank by assets -- but it’s hardly a monopoly maker.

Assuming this goes through, Royal Bank got these assets at less than 10x HSBC Canada’s 2024 adjusted earnings.

The Bottom Line

Royal Bank currently trades at a reasonable 12.2x its trailing 12-month earnings.  

Of the 11 analysts that cover its stock, eight rates it a Moderate Buy or Strong Buy, with a mean target price of $141.40, 8% higher than where it’s currently trading. 

As I wrote earlier, the combination of capital appreciation and dividends makes Royal Bank an excellent long-term investment.

That’s especially true should it complete its latest acquisition.  

If you’re looking for an option to play on Royal Bank, I like the Jan. 19/2024 $120 call contract with a $1,785 premium. The breakeven is just 4%. By the call’s expiry, the deal will have gotten done, and you’ll have made money on your bet on Royal Bank. 

If not, you’re only out the $1,785 per contract.  

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