Are Canadian Banks Too “Toxic” to Hold Through 2020?

CIBC (TSX:CM)(NYSE:CM) is the cheapest Canadian bank by far, but here’s why now is not the time to back up the truck.

| More on:

Don’t bank on a massive rebound in the Canadian bank stocks in 2020.

While growth could begin to pick up after a forgettable 2019 that was full of rising provision for credit losses (PCLs), higher expenses, and thinning net interest margins (NIMs), I’d expect a recovery to be very modest given the existing high risks and still uncompelling valuations. Of course, every bank has a different multiple and risk profile, so your mileage will vary based on which one you bet on.

This piece will have a glimpse at the extreme end of the spectrum, with CIBC (TSX:CM)(NYSE:CM), a domestically overexposed and arguably ill-prepared Canadian bank that got clobbered since the fourth quarter of 2018.

CIBC stock took on a considerable amount of damage over the last two years relative to its peers, and with that, one would think that CIBC would have the most room to run once industry headwinds finally subside.

While shares of CIBC have always traded at a slight discount to the Big Six peer group, the recent valuation gap widening, I believe, is more than warranted as we head into the part of 2020 — a year that could see the Canadian banks continuing to drag their feet.

Will CIBC make up for lost time?

CIBC doesn’t exactly boast a reputation for delivering steady, low-risk growth through both the ups and downs.

The bank got hammered during the Financial Crisis, and I don’t think it’s cleaned up its act since recovering ground over a decade later. It appears that CIBC’s attempt to catch up with its bigger brothers had ironically caused it to lose more ground to some of its “higher quality” peers that showed more discipline when credit was easier.

“It’s been a long time coming to transition into the next credit cycle, and those banks that were overly aggressive (with easier loans) during the upswing are now paying the price with amplified adverse effects that come with a credit downturn,” I said in a prior piece. “That means soaring provisions, among other difficult-to-control issues that could devastate top- and bottom-line numbers.”

One could argue that even at today’s valuation gap isn’t wide enough given CIBC’s relative ill-preparedness for credit’s move toward normalization and how challenging it’s going to be for the bank to tame provisions and potential restructuring expenditures over the year ahead.

CIBC stock has been losing ground to many of its peers amid the overdue Canadian credit downturn — deservedly so.

With the headwinds unlikely to subside entirely in 2020, the Canadian banks face a slate of new challenges as they look to restructure to better deal with the growth-stunting effects that will likely linger on for another year or two.

Yes, CIBC stock is the cheapest it’s been in recent memory, with shares trading at 8.9 times next year’s expected earnings and 1.3 times book, both of which are substantially lower than five-year historical average multiples of 10.3, and 1.75, respectively.

But the “cheapness” of shares doesn’t necessarily mean that CIBC can’t become even cheaper as the harsh industry headwinds continue to take their toll.

If you’re one to believe that the troubles for the banks are only in the early innings, you’d be well-advised to steer clear of CIBC. Of the Big Six banks, CIBC appears to have the most downside risk.

Analysts at Canaccord Genuity recently downgraded the Canadian banks, citing “a toxic mix” of risks and that banks would be “lending less at lower margins.”

Add off-the-charts provisioning into the equation and Canadians should demand a wider margin of safety with the banks, especially CIBC, which is nowhere close to being out of the woods.

While I wouldn’t refer to all Canadian banks as toxic, I would advise cautious optimism on the part of investors and a strong preference for higher performers, which excludes CIBC.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Joey Frenette has no position in any of the stocks mentioned.

More on Dividend Stocks

analyze data
Dividend Stocks

Here’s Why the Average TFSA for Canadians Aged 41 Isn’t Enough

The average TFSA simply isn't enough for most Canadians in their early 40s. Here's how to catch up.

Read more »

cloud computing
Dividend Stocks

Insurance Showdown: Better Buy, Great-West Life or Manulife Stock?

GWO stock and MFC stock are two of the top names in insurance, but which holds the better outlook?

Read more »

concept of real estate evaluation
Dividend Stocks

How to Earn a TFSA Paycheque Every Month and Pay No Taxes on It

Canadian REITs can turn your TFSA into a monthly paycheque machine for life. Here's how Morguard North American Residential REIT…

Read more »

A plant grows from coins.
Dividend Stocks

The Smartest Dividend-Growth Stocks to Buy With $1,000 Right Now

New dividend-growth investors should consider CN Rail (TSX:CNR) stock and another top play if they're looking to build wealth over…

Read more »

Dividend Stocks

The 3 Top Canadian Stocks to Buy With $1,000 Right Now

If you want consistent income, look to consistent dividend payers. These three stocks are some of the best in the…

Read more »

A worker gives a business presentation.
Dividend Stocks

Want a 6% Average Yield? 3 TSX Stocks to Buy Today

These stocks pay good dividends that should continue to grow.

Read more »

chart reflected in eyeglass lenses
Dividend Stocks

Is Alimentation Couche-Tard Stock a Buy for its 0.9% Dividend Yield?

Couche-Tard stock's small yield is not enticing, but its growth potential could be a wealth creator.

Read more »

Hourglass and stock price chart
Dividend Stocks

5.2% Dividend Yield! I’m Buying This TSX Stock and Holding for Decades!

With its 5.2% dividend yield, Toronto-Dominion Bank (TSX:TD) is a stock I'm eagerly buying.

Read more »