Are the big banks a buy heading into earnings season?

The Royal Bank of Canada was the top performer of the Big Six Canadian banks, riding high on diversified revenue and last year's purchase of HSBC. Photo by Peter J Thompson/Postmedia files

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Investors are undervaluing several Canadian banks, but they are generally in good shape as they start reporting second-quarter earnings this week, says one research team.

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“Despite elevated uncertainty in the macroeconomic outlook, with lingering risks of a potential trade war, we are generally constructive on the Canadian banks,” analyst Mike Rizvanovic and associate Felix Fang at the Bank of Nova Scotia said in a note. “We believe the group is as recession-ready as it has ever been.”

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The pair especially like the banks for the “stability and resilience of their Canadian lending business.”

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They said the banks are now better prepared for credit losses and have more “capacity to absorb a spike in losses,” while their tier-one capital ratios, which measure a bank’s financial resilience, have been built up since the COVID-19 pandemic by approximately 200 basis points.

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Here’s how six of the banks (Scotiabank doesn’t cover itself) stack up.

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Royal Bank of Canada

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Rizvanovic and Fang put RBC at the top of the pack for a few reasons: it is a strong player in the Canadian market, its revenue comes from diversified sources, it has a “clean, long-term record” and there are still gains to be had from its purchase of HSBC Canada last year.

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“On top of that, (RBC) tends to be the most trusted of its peers, making it the most popular choice for most Canadian bank investors during times of macroeconomic turbulence, which we are currently facing,” they said.

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Price target: $188

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One-year total return: 15 per cent (including dividends)

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Canadian Imperial Bank of Commerce

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“To put it bluntly, times change, and we do not believe that (CIBC’s) past missteps should have much bearing on how the stock is valued today,” the analysts said, noting it has easily beaten earnings expectations over the past six quarters.

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That plus a healthy capital position that would allow it to buy back shares and a discounted valuation translate to good “upside” for the stock, they said.

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Price target: $98

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One-year total return: 14 per cent (including dividends)

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National Bank of Canada

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Rizvanovic and Fang placed National Bank of Canada among their top picks because its recent relative underperformance provides “investors with a favourable entry point.”

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Investors appear put off by the risk of credit losses at National’s ABA Bank subsidiary and an “uptick” in provisions for credit losses in the last quarter.

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But they think markets are underestimating “the sizable potential upside” from the acquisition of Canadian Western Bank.

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Price target: $135

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One-year total return: 11 per cent (including dividends)

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Toronto-Dominion Bank

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The pair think the recent rally in TD’s stock has run its course and recommend investors should stay on the sidelines until there is more clarity on how long the asset cap on the bank’s retail operation in the United States will last.