This month we focus on the highest weight position in the High Conviction Portfolio, and also amongst the strongest performers, Bank of Montreal.Bank of Montreal, or BMO Financial Group (BMO), is a Canadian bank and financial services company. It was founded in 1817 and is the oldest bank in Canada. It carries out retail, commercial investment banking and wealth management activities, principally in North America and also has operations throughout the world through its investment management subsidiaries, Lloyd George and Foreign & Colonial. It is the fourth largest bank in Canada by market capitalisation and amongst the ten largest in North America.
Like the Australia, Canada is highly regarded as having one of the world’s safest and well-managed banking systems. It is dominated by the ‘Big 5’: Royal Bank of Canada, Toronto Dominion Bank, Bank of Montreal, Bank of Nova Scotia and the Canadian Imperial Bank of Commerce. This makes it highly attractive to us, providing a similar, but diversified exposure to banking operations that are familiar to Australian investors, particularly as a high quality source of capital growth and dividend income.
Bank of Montreal, ranks very highly on the VMQ model, both amongst all banks and the whole investment universe, averaging around the 98th percentile over the last 12 months.
BMO ranks in the top quintile (20%) of companies for both Value and Momentum measures. We evaluate price/book by adjusting the book value for the incremental return earned over the cost of capital for the company, called the economic value added. On this basis the company remains attractive relative to its peers. The Price/Book, Price/Forward Earnings and Loan/Deposit ratios are also sound relative to peers and the bank maintains sensible levels of doubtful debt provisioning.
Momentum reflects both the price return over various time periods, plus the change in analysts assessment of the company. The quintile ranking of the analyst review model reflects a degree of sell side caution that Canadian banks doubtful debt provisions will increase due to pressure from lending to the Oil & Gas sector. The price momentum reflects the strong returns of the company, particularly since we acquired it in early February.
Banks tend to be marked down in the VMQ process because of balance sheet leverage is different to normal companies – and we make other adjustments that takes this into consideration. The important factor that arises from the Quality factors is the standard deviation of earnings per share growth, which is very stable and reflects value for shareholders from a low volatility earnings stream.
Qualitative Analysis
We like the bank’s strategy around increasing market share across its different businesses. There is a slow and steady roll out of simple personal and commercial product lines. It has a significant market share of retail and commercial banking in Canada and also operates in the USA mid-west through BMO Harris Bank. BMO’s acquisitions are consistently of a digestible size, the latest was the GE transport equipment financing business.
We like the bank’s profit mix: retail, commercial and investment banking along with wealth management through its ownership of investment managers Lloyd George and Foreign & Colonial, both of which are not capital hungry businesses. Tier 1 capital is sound at 10.7% prior to the GE deal.
We believe that the market will continue to focus on the stock’s valuation and it’s quality/defensive attributes. The bank has has conservative loan loss provisioning and is acquiring businesses in areas we like such as infrastructure financing.
There is significant value for shareholders from its low volatility, growing earnings stream. Dividends increase in line with earnings and are kept at a sensible level of around 40-50%. This is far more reasonable compared with the dividend overpaying of Australian banks where the average payout ratio is around 78%.
Any catalyst for share price appreciation will be from the realisation of adequate capital and recognition of growth in fee income business. The next company earnings call for Q2 2016 (April, based on 31 October year end) is on 25 May.
The TAMIM Global Equity High Conviction portfolio continues to benefit from its holdings in companies like Bank of Montreal. Over nearly 5 years since its inception the portfolio has delivered 19.7% annualised returns after fees
