By: Jeff Pollock
February 23, 2017
Many haven’t heard of a company called Equitable Group (TSE:EQB). Perhaps that’s because it’s a branchless bank lacking the storefront presence on every major street corner that its competitors command. Nevertheless, EQB is Canada’s ninth largest Schedule 1 bank and provides residential mortgages, commercial lending, and high interest savings products to Canadians. The stock flies under the radar of many investors because its market capitalization is only $1.1 billion, or 0.8% the size of our country’s largest institution, Royal Bank. However, EQB is a stock that Vestcap follows actively due to its inclusion in client portfolios.
The company has generated a more active news flow this past week following its notable Q4 earnings release. EQB reported $2.56 in earnings per share for the last three months of 2016, representing over 30% earnings growth year-over-year, and – for whatever it’s worth – surpassed analyst estimates by almost 17%. As a result, the stock climbed by about 20% the past week to $70 per share.
The company lends to borrowers that fall outside the traditional credit paradigm adhered to by the large banks. Many are business owners or immigrants that lack a history of T4 income. For that reason, more rigorous income verification is required. Following our examination of the Balance Sheet before adding the stock to client portfolios, we realized that the credit losses (as a percentage of the bank’s total loan portfolio) were well below their large Canadian banking peers, further reinforcing our belief that this stock was materially undervalued given its high quality credit metrics and future earnings growth potential.
Despite last week’s appreciation in the stock price, we still view the company as an attractive investment to stick with over the long term.
- First, we expect both the earnings and the dividend to grow by around 10% for the next two years. If history is a guide, which it usually is, EQB’s stock price should follow. The company anticipates 15-17% loan growth in 2017 as it continues to gain market share from its competitors and generate more loan originations for alternative single family mortgages.
- Second, it’s rare to see a high quality bank stock trade below its book value. At today’s $70 stock price, the company is trading at a 4% discount to the figure we believe its book value will be at the end of 2018.
- Third, relative to other Canadian banks, which trade around 11.6x 2017 earnings and 1.6x this year’s estimated book value, EQB trades at only 6.7x earnings and 1.1x its book value. This represents a relative discount of 40% on earnings and 30% on book value.
- Last, because the company is currently paying out a mere 10% of its earnings in dividends, we expect a continuation of regular dividend hikes in the future. By comparison, Canadian banks are presently paying out between 40% and 50% of their earnings to shareholders via dividends. Since 2011, EQB has increased its dividend at least annually. According to several studies, the stock prices of dividend growers historically outperform the market over the long run.
Despite the appreciation in the stock price this past week, we still like the company overall because of the attributes it has to offer. These include a discounted earnings multiple, a cheaper valuation relative to its peers, a history of dividend growth, and a customer base with superior credit quality compared to the larger Canadian banks. For these reasons, we continue to see a positive outlook ahead for EQB.
*Clients of Vestcap and this writer are shareholders of Equitable Group.
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