January 17, 2011 / 4:38 PM / in 7 years

ANALYSIS-Canada's RBC lags in 2010, but set to rebound

* Shares fall 7.2 percent in 2010, underperforming rivals

* Weak trading revenue, U.S. unit hurt quarterly results

* Rebound in trading, U.S. turnaround could boost shares (In U.S. dollars unless noted)

By Cameron French

TORONTO, Jan 17 (Reuters) - Canada’s biggest bank has the most ground to make up this year after lagging its rivals with a 7.2 percent stock decline in 2010, but investors willing to brave near-term volatility could end up with a strong rebound.

Some see Royal Bank of Canada (RY.TO), the most heavily weighted stock on the Toronto Stock Exchange, as a steal at current levels, as sagging market-related revenues should bounce back eventually and the lender’s troubled U.S. unit could cease to be a drag on its bottom line.

“I like this bank,” said Craig Fehr, an analyst at Edward Jones in St. Louis. “I think if you look at it as a bit longer term perspective, the franchise and the growth opportunity is very compelling.”

RBC — whose stock is up 3 percent so far this year, outperforming all but one of its domestic rivals — churned out C$5.2 billion ($5.3 billion) in profit in the fiscal year ended Oct. 31, ahead of Toronto-Dominion Bank(TD.TO) and Bank of Nova Scotia (BNS.TO).

But the shares paid the price for RBC’s ill-timed foray into U.S. retail banking in 2001, and for its relatively high dependence on trading revenue, which fell off sharply in 2010 after an extremely strong 2009.

That brought five straight quarters of disappointing earnings, including a weaker-than-expected profit of C$1.1 billion, or 74 Canadian cents a share, in the most recent three-month period.

It also has eroded the valuation premium that RBC traditionally enjoyed against its domestic rivals.

“In part, they became victims of their own success, in that the capital markets franchise did so well in 2009, that expectations were perhaps too high for 2010,” said Robert Sedran, an analyst at CIBC World Markets.

Also likely weighing on the shares are concerns that global regulators could deep RBC “systemically important” by global regulators, which would force it to hold more capital on its balance sheet and restrict its ability to invest in its growth.


But while investors remain relatively cautious on the shares, observers say many of the negative factors are poised to reverse.

Darko Mihelic, an analyst at Cormark Securities, recently upgraded RBC to “Top Pick” from “Buy”, predicting a rebound in the U.S. retail bank this year, an improvement in capital market revenue.

“We expect the effect of these changes will be that RBC’s (profit) growth will be ahead of peers and its premium valuation will reassert,” he said in a note.

Last year’s industry-wide slump in capital market revenue hurt RBC more than its rivals, due to its outsized investment bank presence.

Its U.S. retail bank has lost money for 10 straight quarters and has generally been a drag on earnings since RBC purchased North Carolina-based Centura Bank for $2.2 billion in 2001. The unit has been hit hard by the U.S. real estate collapse and faced waves of foreclosures.

“Their expansion into the United States was spectacularly badly timed,” said David Baskin, portfolio manager at Baskin Financial Services.

Bank officials have promised to turn the struggling business around, and said recently they expect their international division, which includes the U.S. bank, to return to quarterly profit this year.

RBC Chief Executive Gord Nixon said this week that the bank was focused on fixing the problems in the U.S. unit, and then will decide whether to sell it or build on it.

Some wonder if RBC stock could be in for a rise similar to what it saw in the first quarter of 2005, when the bank reported unexpectedly strong results as capital markets revenue rose. Its then-underperforming shares rose 9 percent. The bank is scheduled to report first-quarter results on March 3.

Few expect the turnaround this this quarter, but Juliette John, a portfolio manager at Bissett Investment management, said the strength of the bank’s core businesses should eventually pay off for investors.

“The domestic business is very very powerful, and the wealth business and the capital markets are going to deliver some good earnings long term, but with some choppiness,” she said. “It’s not going to be a steady stream of earnings like some of its peers.”

$1=$0.99 Canadian Reporting by Cameron French; editing by Rob Wilson

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