Bank on This Under-the-Radar Name and Profit From Higher Rates

For a fair amount of 2020, financial stocks offered well above average dividend yields and compelling valuations. Lately, though, that time has come and gone, with shares appreciating materially. However, just because a great deal is no longer being offered, it does not mean that reasonable propositions do not still exist. Moreover, it doesn't even mean that the opportunity to secure a high dividend yield has passed either. An example of this is Bank of Nova Scotia . Bank of Nova Scotia is an undervalued bank stock with a yield above 4%, and will be a beneficiary if interest rates continue to rise. Business Overview Bank of Nova Scotia (referred to as Scotiabank) is the third-largest financial institution in Canada behind the Royal Bank of Canada and the Toronto-Dominion Bank . Scotiabank provides a diversified suite of financial services, including banking, international banking, wealth management, capital markets services, and more. On Dec. 1 Scotiabank reported fourth-quarter and full-year 2020 results for the period ending Oct. 31, 2020. For the quarter, total revenue fell 3% to ~$5.6 billion in U.S. dollars. Adjusted diluted earnings per share dropped 20% year over year. Scotiabank's big drop in earnings is largely due to prudent loan loss provisioning, which increased 50% from Q4 2019, due to the impacts of the global COVID-19 pandemic. The bank's provision for credit losses ratio was 0.73% (against 0.53% in the year-ago period), as it set aside more money to cover the increase of bad loans from COVID-19 impacts. Despite the difficult fourth quarter, the bank was resilient in 2020 which was a very difficult year for the global economy. For fiscal year 2020, Scotiabank's revenue increased 1% to US$23.5 billion. Adjusted EPS fell 25% as adjusted ROE was 10.4% versus 13.9% in fiscal 2019. The bank's strong business model and competitive advantages means it should benefit once the global economy recovers, and there is already evidence of a recovery. In the 2021 first quarter, net income increased 3% to US$1.9 billion, while EPS equaled US$1.45, a 1.1% increase. This is a positive signal that the company can return to growth in 2021. Growth Prospects During the 2010 through 2020 period, Scotiabank grew its EPS by a 3.2% annualized rate. Of course, this number is skewed in two ways: 1) this is in Canadian dollars, so results fluctuate in U.S. dollars based on the prevailing exchange rate; and 2) it includes 2020's down year. In the 2010 through 2019 period, for example, EPS grew at a 6.9% annualized compound rate. We expect better results in 2021 due to less COVID-19 credit loss provisioning, but this type of risk is important to note, nonetheless. Increased credit provisions can pop up from time to time, resulting in a bit of cyclicality. Scotiabank could see an additional boost its growth from higher interest rates and general economic improvement. Banks generally benefit from higher rates, as loan rates increase quickly while the rates paid on deposits increase slowly. This allows for a larger gap between what the company earns on loans versus what it pays out on deposits. Of course, the offsetting factor at present is the fact that rates have been stubbornly low for quite some time. Still, over longer time periods, higher rates could prove to be a growth driver for financial institutions. Moving forward we expect mid-single-digit EPS growth coming off more normalized earnings for 2021. Recession Performance Scotiabank's competitive advantage is in its international growth strategy, as it is willing to acquire growth outside of its primary markets. When the global economic environment improves, its international strategy should be an advantage for growth. During the financial crisis Scotiabank generated EPS of C$4.03, C$3.06, C$3.31 and C$3.91 in the fiscal 2007 through fiscal 2010 stretch, while the dividend was increased in 2008 and 2009 and frozen in 2010. This is in stark contrast to many financial institutions during this time that posted huge losses and were forced to cut or suspend dividend payments. Dividend Safety Over the past 10 years, Scotiabank's dividend payout has usually been near the 50% range, with 2020 being a slight exception due to lower earnings. The company has paid the same C$0.90 quarterly dividend or ~$0.72 for six straight quarters. This works out to ~$2.88 against ~$5.50 in expected EPS or an expected payout ratio of ~52%. This is more or less typical for a Canadian bank. Speaking of which, it's important to note that the Canadian government levies a withholding tax on dividends paid to out-of-country investors. This may be avoided by owning shares in a retirement account or by claiming an offsetting tax credit, but it is a complication to understand, nevertheless. Also noteworthy is the company's dividend record. The bank declared its initial dividend on July 1, 1833 and has made continuous payments ever since. This is an impressive dividend history which speaks to the company's strong business model and ability to outlast recessions. The dividend growth streak sits at 10 years (in Canadian dollars) due to the freeze during the last financial crisis. Overall, the company's dividend safety appears strong. Based on a current share price near $63, a ~$0.72 quarter dividend and ~$5.50 in expected EPS this year, the shares are presently trading hands with a 4.6% dividend yield, an 11.5 P/E ratio and a ~52% payout ratio. Overall, the stock appears to have a discounted valuation and a high dividend yield, with a secure dividend payout. Final Thoughts Scotiabank may not be on some investors radar due to the Canadian domicile and resulting currency fluctuations and tax consequences. However, the company has a very strong dividend record going back nearly two centuries. Moreover, the current dividend yield is well above average and the bank could benefit from higher rates in the future. As a result, BNS stock is attractive for value and income investors.

Bank on This Under-the-Radar Name and Profit From Higher Rates

Due to its Canadian domicile and resulting currency fluctuations and tax consequences, the bank may not be on investors' minds.

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