The markets are doing their best to bounce back from the steepest bear market in history. Last week, the S&P/TSX Composite Index eked out a 0.42% gain, and it is now up 12% since the start of April. Increasingly, the market rally looks sustainable, and investors are looking to once again buy into the markets. Canada’s big banks should be at the top of your list.
The market is rallying on the backs of only a few sectors — tech in particular. While technology stocks are hitting 52-week highs, financials continue to struggle. The S&P/TSX Financial Index is only up 1.2% in April, far below the Index average.
Year to date, financials are trailing the index by approximately 10 percentage points. Canada’s big banks are usually strong performers. This is not so in 2020, as all the Big Five are trailing the Index.
Since they have yet to find their footing, it remains a good time to pick up Canada’s big banks at discounted valuations. Here are two of the cheapest.
Canada’s worst-performing big bank
Let’s start with the worst performing of the Big Five, Bank of Montreal(TSX:BMO)(NYSE:BMO). In 2020, Bank of Montreal stock is down by 32.91%, far outpacing its peers.
Why the underperformance? On the surface, the bank is one of the most exposed to the Canadian oil and gas industry. With oil prices trading at prices not seen in decades, the entire industry is at risk of insolvency. This means that banks with high exposure could potentially experience high loan losses.
Unfortunately, Canada’s big banks don’t report quarterly results until the end of May. As such, investors won’t get clarity on the magnitude of impact until such time. That being said, I believe Bank of Montreal is trading at levels that are tough to ignore.
Let’s put BMO’s exposure to oil and gas into perspective. First, oil and gas only account for approximately 2.5% of outstanding loans. Second, when you take into account the undrawn credit facilities, Bank of Montreal is actually one of the least exposed to the industry.
The bank is trading at only 7.01 times earnings, 1.01 times book value, and at a 37.2% discount to historical averages. There is none cheaper among Canada’s big banks.
A top performer
Speaking of cheap, another Big Five bank that is currently trading at a big discount to historical averages is Toronto-Dominion Bank(TSX:TD)(NYSE:TD). As of writing, TD Bank is trading at a 32.3% discount to historical averages. In fact, it has only been this cheap once before, and that was during the Financial Crisis.
Over the past decade, TD Bank has been the best-performing Canadian big bank. In 2020, its 24.66% loss is second only to RoyalBank of Canada. Why does it consistently outperform? It has the highest exposure to the U.S. markets. Since the U.S. has far outpaced the Canadian economy, it is therefore not surprising that TD Bank has outperformed the Big Five.
Across the board, earnings growth is expected to turn negative in 2020. In 2021, TD Bank is expected to post earnings-growth rates of 5.71%. Although below the company’s five-year double-digit average, it is the second-highest growth rate among Canada’s big banks.
Finally, TD Bank’s dividend is among the safest in the world. At 43%, it has the lowest payout ratio of its peers and has averaged higher dividend growth. Earlier this year, the company raised the quarterly dividend by 6.76%.
As the U.S. looks to re-open, TD Bank will surely be among the first of Canada’s big banks to rebound in a broader market rally.
OPEC and its partners concluded their meeting on Saturday afternoon, announcing that it would extend its current production cut deal.
Algeria’s Energy Minister Mohamed Arkab, OPEC’s current President summed up the group’s sentiment by saying that “Despite the progress achieved to date, we cannot afford to rest on our laurels,”.
The last couple of days, the cartel’s de-facto leader Saudi Arabia negotiated with other OPEC members and some non-OPEC countries including Russia, Kazakhstan and Azerbaijan to extend the current 9.7 million bpd output cuts for at least another month.
Most countries partaking in the record production cuts were willing to continue the current deal, but poor compliance from countries like Iraq, Nigeria and Kazakhstan has caused discontent among other OPEC members, some of which have even made deeper cuts than agreed on in April.
During the virtual meeting on Saturday, the cartel agreed that the countries that were unable to reach full conformity in May and June will have to compensate for this in July, August and September.
Oil prices effectively doubled during the month of May as global demand started to recover and record output cuts and worldwide well shut-ins decreased the monster glut.
While the OPEC+ deal extension undoubtedly will have a bullish effect on markets, prices aren’t likely to rip much higher on Monday as the OPEC+ news has largely been priced in already.
For oil prices to make a full recovery, global demand will have to recover and crude inventories have to be drawn down, both of which will likely take up to two years. Pioneer’s Scott Sheffield said that the quick rebound of demand to around 94-95 mb/d following the “reopening” of so many economies will give way to stagnation, saying that demand won’t reach pre-pandemic levels until 2022 or even 2023.
For now, the next bullish catalyst for oil could come from Saudi Aramco, which could set the trend for higher oil prices in June as it is expected to release its OSPs (official selling prices) on Monday. Aramco’s OSPs are often a leading indicator for Iraqi, Iranian and Kuwaiti crude prices, and last month, Brent futures rallied after Riyadh hiked its prices for crude to Asia.
OPEC, Russia and allies agreed on Saturday to extend record oil production cuts until the end of July, prolonging a deal that has helped crude prices double in the past two months by withdrawing almost 10 per cent of global supplies from the market.
The group, known as OPEC+, also demanded countries such as Nigeria and Iraq, which exceeded production quotas in May and June, compensate with extra cuts in July to September.
OPEC+ had initially agreed in April that it would cut supply by 9.7 million barrels per day (bpd) during May-June to prop up prices that collapsed due to the coronavirus crisis. Those cuts were due to taper to 7.7 million bpd from July to December.
“Demand is returning as big oil-consuming economies emerge from pandemic lockdown. But we are not out of the woods yet and challenges ahead remain,” Saudi Energy Minister Prince Abdulaziz bin Salman told the video conference of OPEC+ ministers.
Benchmark Brent crude climbed to a three-month high on Friday above $42 a barrel, after diving below $20 in April. Prices still remain a third lower than at the end of 2019.
WATCH | Canadian oil producers don’t see relief after OPEC deal to cut output:
Richard Masson, chair of World Petroleum Council-Canada, says Ottawa needs to move soon if it plans to help producers, as companies face ‘really tough decisions.’ 0:55
“Prices can be expected to be strong from Monday, keeping their $40 US plus levels,” said Bjornar Tonhaugen from Rystad Energy.
Saudi Arabia, OPEC’s de facto leader, and Russia have to perform a balancing act of pushing up oil prices to meet their budget needs while not driving them much above $50 US a barrel to avoid encouraging a resurgence of rival U.S. shale production.
1 billion barrels of excess oil inventories
The April deal was agreed under pressure from U.S. President Donald Trump, who wants to avoid U.S. oil industry bankruptcies.
Trump, who previously threatened to pull U.S. troops out of Saudi Arabia if Riyadh did not act, spoke to the Russian and Saudi leaders before Saturday’s talks, saying he was happy with the price recovery.
While oil prices have partially recovered, they are still well below the costs of most U.S. shale producers. Shutdowns, layoffs and cost cutting continue across the United States.
As global lockdown restrictions to halt the spread of the coronavirus are being eased, oil demand is expected to exceed supply sometime in July but OPEC has yet to clear 1 billion barrels of excess oil inventories accumulated since March.
Tonhaugen said Saturday’s decisions would help OPEC reduce inventories at a rate of 3 million to 4 million bpd over July-August.
“The quicker stocks fall, the higher prices will get. And that is crucial for many OPEC+ economies, whose fiscal budgets count on oil sales,” he said.
Nigeria’s petroleum ministry said Abuja backed the idea of compensating for its excessive output in May and June.
Iraq, with one of the worst compliance rates in May, agreed to extra cuts although it was not clear how Baghdad would reach agreement with oil majors on curbing Iraqi output.
Iraq produced 520,000 bpd above its quota in May, while overproduction by Nigeria was 120,000 bpd, Angola’s was 130,000 bpd, Kazakhstan’s was 180,000 bpd and Russia’s was 100,000 bpd, according to OPEC+ data.
OPEC+’s joint ministerial monitoring committee, known as the JMMC, would now meet every month until December to review the market, compliance and recommend levels of cuts.
The next JMMC meeting is scheduled for June 18, while the next full OPEC and OPEC+ meeting will take place on Nov. 30-Dec. 1.
OPEC+ agreed to a one-month extension of its record output cuts and adopted a stricter approach to ensuring members don’t break their production pledges.
The deal will underpin the oil market recovery, easing the financial pain felt by resource-dependent emerging economies, shale explorers in Texas, and blue-chip companies like Royal Dutch Shell Plc.
It’s a victory for Saudi Arabia and Russia, who put a destructive price war behind them to successfully cajole Iraq, Nigeria and other laggards to fulfill their promises to cut production. The two leaders of OPEC+ showed that they intend to keep a close watch on the oil market, meeting every month to assess the balance between supply and demand amid an uncertain economic recovery from the global pandemic.
“Our collective efforts have borne fruit, and despite many uncertainties, there are encouraging signs that we are over the worst,” said Saudi Energy Minister Prince Abdulaziz bin Salman. “Demand is returning as big oil-consuming economies emerge from pandemic lockdown,” he added.
After a video conference lasting several hours on Saturday, delegates said all nations had signed off on a new deal for a production cut of 9.6 million barrels a day next month. That’s 100,000 barrels a day lower than the reduction in June because Mexico will end its supply constraints, but a tighter limit than the 7.7 million barrels a day set for July in the group’s previous agreement.
In addition, the communique states that any member that doesn’t implement 100 per cent of its production cuts in May and June will make extra reductions from July to September to compensate for their failings.
Those promises are a particular vindication for the Saudi minister, who has consistently pushed fellow members to stop cheating on their quotas since his appointment last year.
But they could also add an element of risk. In theory, the entirety of the 23-nation production agreement, which runs until April 2022, is now contingent on every member making 100 per cent of their pledged cuts, according to the communique. That’s something rarely achieved in the three-and-a-half years that OPEC+ has existed, or indeed the decades-long history of the Organization of Petroleum Exporting Countries itself.
Oil has just posted a sixth weekly gain in London, more than doubling to US$42.30 a barrel since April with traders anticipating tighter supplies as demand recovers from lockdown. U.S. President Donald Trump on Friday hailed the cuts from OPEC and its allies for saving America’s energy industry, and U.S. Energy Secretary Dan Brouillette welcomed the deal on Saturday.
I applaud OPEC-plus for reaching an important agreement today which comes at a pivotal time as oil demand continues to recover and economies reopen around the world.https://t.co/Z47PT8uqtp
The oil market “is still in a fragile state and needs support,” Russia’s Energy Minister Alexander Novak said in opening remarks at the virtual meeting. “That is why today more than ever it is important to adhere to 100 per cent compliance.”
The group hopes to build on its success by pushing the market into a supply deficit next month, using a price structure called backwardation to start to chip away at the billion barrels of oil stockpiles that built up during the pandemic.
There was no discussion in the meeting about the future of the additional 1.2 million barrels a day of voluntary output cuts being implemented by Saudi Arabia and its Gulf allies in June, delegates said.
The cartel will meet again in the second half of June for another review of the oil market. Talks are scheduled on June 18 for the Joint Ministerial Monitoring Committee, which could recommend a further extension if it’s deemed necessary, pushing the deep production cuts into August, a delegate said. That panel will meet every month until December, according to the communique.
The next full ministerial OPEC+ meeting has been scheduled for Nov. 30 to Dec. 1, delegates said, although the communique notes that a conference could be held whenever it is required.
Cutting production is always painful for oil-dependent states. Iraq in particular needs every penny because it’s still rebuilding its economy following decades of war, sanctions and Islamist insurgency.
The country made less than half of its assigned cutbacks last month, so compensating fully would require it to slash production by a further 24 per cent to about 3.28 million barrels a day, according to Bloomberg calculations. Accepting such terms could risk a backlash from Iraqi parliamentarians and rival political parties for bowing to foreign pressure.
The traditional shirkers in OPEC+ have promised many times before to do better. Some analysts were skeptical that this occasion will be any different.
“Everyone saves face with this agreement,” Jan Stuart, global energy economist at Cornerstone Macro LLC, said on Friday after a tentative deal was in place. “But it begs the question: What is the enforcement mechanism? I’m very curious to see how the organization is going to elicit greater compliance from the cheaters.”
There’s also a risk that future OPEC+ curbs could be undermined by a return of Libyan oil. The civil war there halted more than one million barrels a day of production, helping OPEC+ rebalance the market, but a cease fire now opens the door for a gradual recovery of supply.
For now at least, members of OPEC+ can enjoy the price gains resulting from their deal.
“The oil market is on its way to recovery,” said Ann-Louise Hittle, oil analyst at consultant Wood Mackenzie Ltd. “Supply has shifted dramatically already”
–With assistance from Julian Lee and Khalid Al-Ansary.
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