We believe that Scotiabank has a narrow moat tied to cost advantage and switching costs. It has a large Latin America exposure, contributing around 40% of its revenue. The bank also has the smallest Canadian exposure among its peers, with around 50% of revenue from Canada. It is not the most dominant player in its international banking markets and these markets often expose the bank to higher credit costs and more volatile returns than peers.
· Morningstar Rating: ★★★★
· Morningstar Economic Moat Rating: Narrow
· Morningstar Uncertainty Rating: Medium
Under its new CEO Scott Thomson, the bank is exiting some of its Latin American markets with a focus on the “North American corridor” (Canada, US, and Mexico). The bank divested some of its international businesses and also invested in a 14.9% stake in KeyCorp to increase its US exposure. We still view the Canadian market as having the most attractive return profile and would like to see the bank have domestic share gains and better execution.
Our fair value estimates of CAD 76 and USD 53 imply 1.6 times the bank’s tangible book value at the end of January 2025. The decrease mostly comes from incorporating the CAD 1.36 billion impairment losses related to selling its banking operations in Colombia and Central America. We forecast the bank to average between 2.5% and 4% loan growth over the next five years. We project its net interest income to grow at a 3.5% compound annual growth rate at the same time, from balance-sheet growth and some margin expansion. We forecast Scotiabank’s normalized return on tangible equity at 14%, well above our assigned cost of equity of 10%.
We think its North American corridor strategy is a more focused one compared with its previous focus on favoring growth in international markets without earning the appropriate risk-adjusted margins. We think the bank’s incremental capital allocation of “Canada first, US second, and Mexico third” largely makes sense. We view the Canadian market as the most favorable one and the bank has shed some domestic market shares in the past few years because of its focus on international expansion. As for the US, the bank’s 14.9% equity stake in KeyCorp will not significantly increase its US earnings exposure, but it gives Scotiabank a chance to observe the US retail banking market. The deal has a five-year standstill element, which enables Scotiabank to have some flexibility with this minority investment. With respect to Mexico, the tariff situation creates some uncertainty and we think it will be prudent for the bank not to increase its capital deployment for the short term.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
