Lowering Our Fair Value Estimate for Royal Bank of Canada Slightly After Q2 Earnings

Royal Bank of Canada RY is one of the two largest banks in Canada by assets and one of six that collectively hold roughly 90% of the nation’s banking deposits. The bank derives two thirds of its revenue from Canada, with the rest primarily coming from the United States. It has done an admirable job of expanding its nonbank lines of business, running efficient banking operations, and generating some of the best returns for shareholders in the industry. We believe RBC should remain one of the dominant Canadian banks for years to come, even as a more difficult macro backdrop pressures earnings growth in the medium term.

We expect Royal Bank of Canada to remain a steady player in its retail and commercial Canadian banking operations. It also remains a major player in global capital markets. We expect this segment to continue to be a strong contributor to net income, and if anything, capital markets have been countercyclical for the bank during the pandemic as earnings have soared for the unit.

The wealth-management segment also earns strong returns on equity, and large inflows have led to a top market position. RBC remains a top asset manager and gatherer in Canada, and is also experiencing outsize growth from City National, where cross-selling and client integration efforts have gone well. The banks’ distribution networks are arguably the most dominant in Canada, and the bank has the largest amount of assets under management among the Canadian banks.

We like RBC’s growth strategy in the U.S. through City National, focusing on wealth and commercial clients. We believe this is a much more focused strategy than its previous attempts at growth in the U.S., and it is paying dividends. While exposure to the U.S. isn’t as great right now given some of the industry turmoil, deposit and earnings pressure has been manageable.

We are relatively neutral on RBC’s latest announced acquisition of HSBC Canada. It is a decent franchise with a decent client base and will allow RBC to gain some incremental share in Canada, however, we believe client retention risks, the price paid, and regulatory risks make this a roughly neutral move.