The Bank Of Nova Scotia: A Rare Opportunity For A Rock Solid 6.4{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} Yield (NYSE:BNS)

William Arsn

Investment Thesis

In March 2020, in the midst of the market crash, I took a close look at the value and dividend characteristics of Canada’s Big 5 banks. At the time, Canada’s 5 largest banks: Royal Bank of Canada (RY), The Toronto-Dominion Bank (TD), The Bank of Nova Scotia (BNS), The Bank of Montreal (BMO) and Canadian Imperial Bank of Commerce (CM) were all trading at deep discounts to their historic valuations. The combination of low share prices and continuity in dividend payments had resulted in dividend yields that averaged 68{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} above 5-year averages in March 2020. Five months later, this average yield premium has closed to approximately 30{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} – about half of the yield premium from March 2020. While the sector has recovered somewhat, the Bank of Nova Scotia has lagged its peers in recovering. For long-term dividend growth investors, Scotiabank’s current level offers great value and an attractive yield.

Value in a Great Sector

For dividend growth investors with long-term time horizons, the Canadian banks tick a lot of boxes. These companies have stable business models in a protected sector with strong dividend growth records. With the recent market turbulence caused by the global pandemic, prices of bank stocks have reached some of their most attractive levels since the global financial crisis. I like the Canadian Banking sector in general, and it is hard to go too far wrong with any of the Big 5. In particular, RY, TD, and BNS are some of my core long-term holdings. With an interest in both dividend growth and value, I have recently been adding to the Bank of Nova Scotia and Toronto-Dominion Bank due to their compelling current valuations and attractive dividend yields. From a value perspective and dividend profile, the current standout in this group is the Bank of Nova Scotia.

Company Profile

The Bank of Nova Scotia has a market capitalization of C $68B and assets of over $1.2T. Scotiabank – as the company is branded, has 97,000 employees, and serves over 25 million clients in the Americas. Using the proceeds from the bank’s high margin Canadian operations, Scotiabank has built a significant presence in Latin America with a focus on the Pacific Alliance countries of Mexico, Peru, Columbia, and Chile. In recent years, the bank has made efforts to grow its wealth management business through large acquisitions in an effort to diversify away from its Canadian retail banking focus. Scotiabank trades on the Toronto Stock Exchange and New York Stock Exchange under the ticker “BNS”. For a closer look at BNS’s operations and growth positioning, please see my analysis here.

Source: Scotiabank Investor Presentation

Compelling Dividend Yield

Scotiabank is currently yielding over 6.4{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05}; a staggering 44{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} premium over the bank’s historic dividend yield of 4.49{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05}. The company’s yield in 2020 is at its highest level since 2008-2009 when the yield topped 8{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05}. For investors looking for an attractive dividend income name, Scotiabank is at its most attractive level in a decade.

Table Source: Author; Data Source: Morningstar

In addition to the high current yield, Scotiabank also has an incredible history of dividend growth dating back 137 years. In the last decade since the global financial crisis, Scotiabank has offered dividend investors 6{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} CAGR. These steady semi-annual dividend increases have rewarded investors quarter after quarter with growing streams of reliable income.

Table Source: Author; Data Source: Morningstar

Comparatively Attractive

Over the last 5 months, shares of the Canadian banks have recovered steadily. With these increasing share prices, dividend yields have moderated from their dramatic March 2020 premium. The compression of this premium over the last 5 months has been steady but not uniform. Scotia’s yield held up better than TD, CM, and BMO in March. However, it has been slower to recover than any of the other 4 large Canadian banks.

Table Source: Author; Data Source: Morningstar

The compression of Scotiabank’s dividend premium from March to August was 21{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05}, compared to an average of 36{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} for the group. This slow recovery offers investors an opportunity to take advantage of this comparatively high dividend yield by adding to positions.

Table Source: Author; Data Source: Morningstar

Dividend Safety

Since 2009, Scotiabank has averaged 8{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} annual EPS growth. With EPS growth outpacing dividend growth, the company has been able to maintain a reasonable payout ratio that has averaged 49.5{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} over the last 5 years. With a current payout ratio of approximately 59{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05}, Scotia’s payout ratio is almost 19{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} above the company’s average. While higher than the company’s dividend payout target range of 40-50{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05}, the current payout is in line with the average premium the other large Canadian banks are currently offering.

Table Source: Author; Data Source: Morningstar

The Office of the Superintendent of Financial Institutions Canada or OSFI, lists all of the Big 5 banks in Canada as domestic systemically important banks or D-SIBs. The OSFI has asked the banks to refrain from share buyback programs or from raising dividends in the midst of the COVID-19 pandemic, but has allowed them to maintain dividend payouts going forward. According to the OSFI’s April 2020 statement:

The Domestic Stability Buffer is countercyclical by design as it requires reserves to be built up in good times so that when risks materialize, banks are able to do more than just absorb losses; they are also able to continue to support the economy through lending, providing services to customers and paying dividends.

There is a broad understanding among regulators, analysts, and investors that the Canadian banks are held up to be examples of stability during economic turbulence. According to analyst Meny Grauman of Cormark Securities,

“There’s an investor premium earned as a result of that huge amount of time, safety and security of the dividend. You’d rather keep that intact and go raise equity at less than preferable terms”.

Scotiabank and its peers have a vested interested in maintaining current dividend payouts, even if it drives up payout ratios in the short term.

Scotiabank has paid a dividend continuously since 1883 and has increased the dividend in 43 of the last 45 years. This dividend is supported by a vast and diversified business that features a high degree of recurring income. It is worth noting that the Bank of Nova Scotia maintained its dividend during the global financial crisis a decade ago and resumed dividend growth in 2011 during the recovery. This dividend, like those of the other large Canadian banks, is very safe. Scotiabank is unlikely to grow the dividend this year, or perhaps even in 2021; however, I am very confident that Scotia’s dividend is safe at current levels.

Investor Takeaways

In addition to the comparative attractiveness within the Canadian banking sector, Scotiabank’s current 6.4{5667a53774e7bc9e4190cccc01624aae270829869c681dac1da167613dca7d05} yield is attractive on a historical basis. The current yield will not last, so investors interested in long-term dividend growth can take advantage of current price weakness to add to positions. I recently doubled-down on Scotiabank with the intention to hold and DRIP shares for the next few decades.

Disclosure: I am/we are long BNS, TD, RY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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