ROYAL BANK OF CANADA $56 (Toronto symbol RY; Conservative Growth Portfolio, Finance sector; Shares outstanding: 1.4 billion; Market cap: $78.4 billion; Price-to-sales ratio: 2.2; Dividend yield: 4.1%; TSINetwork Rating: Above Average; www.rbc.com) is Canada’s largest bank, with $815.0 billion of assets.
The U.S. Commodity Futures Trading Commission (CFTC) recently accused Royal of using a complex series of trades to cut its tax bill in Canada. Specifically, the CFTC says that divisions of the bank bought Canadian and U.S. dividend-paying stocks (plus futures contracts on these stocks) and quickly sold them to other divisions. These transactions would let Royal earn tax credits on the dividends it received from these holdings.
The CFTC claims that this process was a wash trade, in which the bank artificially set prices for these transactions, instead of letting the market determine the prices. Royal has denied these allegations, and we agree with Royal. As well, any potential fine would likely be small next to Royal’s earnings.
Royal also recently agreed to buy the 50% of RBC Dexia Investor Services that it does not already own. Formed in 2006, this 50/50 joint venture provides safekeeping and administration services (including holding securities and processing transactions) to institutional investors.
Royal will pay $1.1 billion for this stake when the deal closes in mid-2012. Based on the price it is paying, accounting rules will also force Royal to write down the value of its existing 50% interest in this venture by $170 million. However, this business has steady revenue streams and is profitable. The purchase should begin adding to Royal’s earnings in 2013.
Meanwhile, the bank earned $1.9 billion, or $1.23 a share, in the first quarter of fiscal 2012, which ended January 31, 2012. That’s down 6.0% from $2.0 billion, or $1.31 a share, a year earlier. Lower profits from Royal’s securities-trading business was the main reason for the earnings decline.
Royal set aside $267 million to cover bad loans in the latest quarter, up slightly from $264 million a year earlier. Revenue rose 4.9%, to $7.6 billion from $7.2 billion.
The bank will probably earn $4.88 a share in fiscal 2012. The stock trades at 11.5 times that estimate. The $2.28 dividend yields 4.1%.
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