Royal Bank Of Canada Is A Royal Stock

### The Enduring Strength of Royal Bank of Canada: A Comprehensive Analysis

#### **1. An Undervalued Gem in the Banking Industry**

The Royal Bank of Canada (RY) has long been a standout performer in the banking sector, and yet, its stock remains undervalued in the market. I first identified RY as a promising investment opportunity in April 2018, and as of September 2023, this bullish outlook remains unwavering. The bank’s diversified business model, leadership in the industry, growing net interest margins, and attractive valuation all contribute to its undervalued status. RY continues to demonstrate robust growth in deposits, loans, net interest income, and net interest margins, making it a compelling choice for investors seeking both stability and growth.

The Risk/Reward profile of RY is particularly favorable, driven by several factors:

1. **Continuous Loan and Deposit Growth**: RY has consistently expanded its loan and deposit base, which forms the backbone of its profitability. This growth is a testament to the bank’s strong market position and customer trust.

2. **Improving Net Interest Margin (NIM)**: Despite challenges posed by fluctuating interest rates, RY has managed to enhance its NIM, which is a key indicator of a bank’s profitability.

3. **Strong Free Cash Flow Generation**: The bank’s ability to generate significant free cash flow underscores its financial health and capacity to return value to shareholders through dividends and share buybacks.

4. **Attractive Stock Valuation**: RY’s stock is currently undervalued, offering investors an opportunity to acquire a high-quality asset at a favorable price.

#### **2. Maintaining Its Leading Position**

Royal Bank of Canada’s dominance in the banking sector is unparalleled. It leads in key personal and business banking product categories across Canada, and its investment banking prowess extends beyond borders. As the #1 ranked investment bank in Canada and the 10th largest globally, RY’s reputation and reach are significant. Additionally, its position as the 6th largest wealth advisory firm in the U.S. by assets under administration (AUA) further solidifies its market leadership.

This leadership is not merely a status symbol; it translates into tangible business benefits. A strong market position often leads to better customer retention, cross-selling opportunities, and operational efficiencies, all of which contribute to sustained growth and profitability.

#### **3. Rising Net Interest Income and Margins**

One of the key drivers of RY’s success is its ability to manage its net interest income and margins effectively. In 2024, the bank reported an impressive 11% year-over-year (YoY) increase in net interest income, with a corresponding rise in net interest margin to 1.54%. This performance is remarkable, especially considering the challenging environment of rising interest rates in both the U.S. and Canada.

The bank’s success is not limited to a single segment; its Personal Banking, Commercial Banking, Wealth Management, Insurance, and Capital Markets divisions all contributed to the growth in net income. This diversified growth underscores the bank’s balanced and robust business model.

#### **4. Loans and Deposits Are Growing at a Fast Pace**

RY’s ability to grow its loans and deposits simultaneously is a rare feat in the banking industry. Between fiscal 2019 and fiscal 2024, net loans increased from $470 billion to $704 billion, reflecting an 8.4% compound annual growth rate (CAGR). Similarly, total deposits surged from $673.3 billion to $1.0 trillion, marking an 8.5% CAGR over the same period.

This dual growth in loans and deposits indicates a healthy balance sheet and effective asset-liability management. It also points to RY’s ability to attract and retain customers, which is vital for sustained growth in the competitive banking landscape.

#### **5. Quality Capital Ratio**

A strong capital position is a cornerstone of banking stability, and RY excels in this aspect. The bank has maintained an average tier 1 common equity (CET1) ratio of 13.4% over the past three years, with a notable improvement from 9.9% in fiscal 2014 to 13.2% in fiscal 2024. Although the acquisition of HSBC Canada in March 2024 led to a slight decline in CET1 ratio, the bank’s internal capital generation and share issuances have cushioned the impact.

This strong capital ratio not only ensures regulatory compliance but also provides a buffer against potential economic downturns, making RY a safe investment during uncertain times.

#### **6. Attractive Dividend Yield and Free Cash Flow**

Investors in RY are rewarded with an attractive dividend yield of 3.4%, reflecting the bank’s commitment to returning value to shareholders. Since fiscal 2019, RY has distributed $28.7 billion in dividends, representing 17% of its market capitalization. Additionally, the bank has implemented a share buyback program, albeit with modest repurchases so far.

RY’s free cash flow (FCF) has been impressive, generating $58 billion cumulatively since fiscal 2014, which is 32% of its enterprise value. This strong FCF not only supports dividend payments but also provides flexibility for strategic acquisitions and investments in growth initiatives.

#### **7. Economic Headwinds and Future Prospects**

While economic challenges persist, such as lingering inflation and the Federal Reserve’s cautious approach to rate cuts, RY has proven its resilience. The bank’s diversified business model and strong financial position enable it to navigate through various economic cycles effectively. Moreover, the expected increase in mergers and acquisitions activity under the new U.S. presidential administration could provide additional growth opportunities for RY’s investment banking business.

Using a reverse discounted cash flow (DCF) model, the stock’s current price implies a price-to-economic book value (PEBV) ratio of 1.0, suggesting that the market expects no growth in net operating profits after tax (NOPAT). However, RY’s historical performance tells a different story, with NOPAT growing at a compounded annual rate of 4% over the past decade. This disparity indicates that RY’s stock has significant upside potential.

In different scenarios, the stock could be worth between $123 and $151 per share, representing a potential upside of 24%. These projections are based on reasonable assumptions about NOPAT margins and revenue growth, both of which are supported by RY’s historical performance. The bank’s ability to grow NOPAT more in line with historical levels could unlock even greater value for investors.

In conclusion, Royal Bank of Canada is a compelling investment opportunity, offering a unique combination of growth, stability, and attractive valuation. Its diversified business model, strong capital position, consistent profitability, and shareholder-friendly policies make it a standout performer in the banking industry. Despite economic headwinds, RY’s proven track record and future growth potential position it as a prime candidate for investors seeking long-term value.