2023-09-18 10:19:30 ET
Summary
- Toronto-Dominion Bank is Canada's second-largest bank with a $113 billion market cap and offers a 4.6% dividend yield.
- TD has consistently increased its dividend every year and has been a top-performing bank in Canada and North America.
- The bank faces challenges from a weakening economy and potential regulatory changes, but remains well-positioned with a diversified business model. However, the current economic uncertainty may not justify immediate investment.
Introduction
I have covered a number of fascinating Canadian stocks over the past few years, mainly focused on railroads, miners, and energy companies.
However, Canada isn't just known for having some of the best transportation and resource companies, but it also has been a source of steadily rising banking income for millions.
In this article, we'll take a closer look at its second-largest bank, the Toronto-Dominion Bank ( TD ) . Canada's second-largest bank with a $113 billion market cap in New York offers a 4.6% dividend yield, consistent dividend growth, and a strong business model capable of growth in areas like wealth management.
The problem is that banks, in general, have a somewhat poor long-term risk/reward, especially in light of ongoing challenges.
Hence, at the end of this article, I'll present my view on TD and explain how I would deal with this stock as a dividend (growth) investor.
So, let's get to it!
The TD Dividend And Outperformance
Unlike most North American banks, Toronto-Dominion has kept its dividend unchanged during the Great Financial Crisis. Since then, it has hiked its dividend every single year.
Currently, the stock pays a CAD 0.96 per share per quarter dividend. This translates to a yield of 4.6%.
On December 1, 2022, the company hiked its dividend by 7.9%. The five-year average annual compounding dividend growth rate is 6.9%.
The dividend is protected by a 47% payout ratio, which is well within the company's desired payout range of 40% to 50%.
Furthermore, the company has paid a dividend for 166 consecutive years.
The only thing I need to mention here is that TD pays its dividends in Canadian dollars. It also reports its financials in Canadian dollars.
Hence, dividends received in USD are subject to currency fluctuations. The same goes for any other currency, of course.
Furthermore, the company has been a great source of returns for its investors.
According to the company's own data, it has been the second-best-performing bank in Canada for the past decade. Additionally, it has ranked fourth in North America during this time.
Looking at the chart below, we see that Toronto-based TD shares have returned 174% over the past ten years. This beats the financials ETF ( XLF ) by roughly 20 points and the SPDR Bank ETF ( KBE ) by roughly 120 points.
NY-listed shares have returned 107%, which was largely caused by unfavorable currency developments, which is always a risk when dealing with this bank.
Over the past five years, the company has grown its adjusted earnings per share by 8.6% per year, boosted by buybacks, as compounding earnings growth during this period was slightly lower.
So far, so good.
Dissecting the dividend is easy. Assessing the risk/reward is much more complicated - especially in this environment.
What's TD Up To?
The company needs to monitor two major markets. The U.S., which is the biggest economy in the world, and Canada, its home market, is the world's 9th-largest economy.
In 2022, close to 40% of its revenue came from the United States.
It also needs to be said that this bank, with more than CAD 440 billion in deposits, has a well-diversified income profile.
Only a third of its business is Canadian Personal and Commercial Banking. U.S. retail accounts for a quarter of its revenues. Wealth and Insurance sales account for more than a fifth of total sales.
CAD in Million | 2022 | Weight |
---|---|---|
Canadian Personal and Commercial Banking | 16,586 | 33.8 % |
United States Retail | 12,425 | 25.3 % |
Wealth and Insurance | 10,860 | 22.1 % |
Wholesale Banking | 4,831 | 9.9 % |
Corporate | 4,330 | 8.8 % |
One of the problems facing TD and its peers is a weakening economy.
As the Wall Street Journal reported on September 6, the Bank of Canada held its rates steady as the economy slowed down further.
According to the article, the Bank of Canada decided to keep its main interest rate at 5%, following consecutive rate hikes in June and July. The bank noted a weakening economy and reduced labor-market pressures as reasons for this decision.
Despite the current stance, the Bank of Canada expressed concerns about persistent underlying inflationary pressures. It affirmed its readiness to raise rates again if conditions do not improve.
Over the past year, the Bank of Canada, similar to the U.S. Federal Reserve, has aggressively increased rates to combat inflation, totaling 4.75 percentage points.
So, just like the Fed, the Bank of Canada is unable to cut rates, as the threat of inflation remains too high. This is also an issue for banks.
After all, the Canadian per capita gross domestic product has declined for four consecutive quarters, which reflects a 2% decrease in the second quarter compared to the previous year.
During the recent Scotiabank Annual Financial Summit Conference , TD commented on economic challenges, as it acknowledged the unpredictability and regional variations in the U.S. market, emphasizing the importance of adapting to changing economic circumstances.
The company also noted potential regulatory changes, economic uncertainties, and the need to manage expenses while strategically investing in critical areas such as technology and infrastructure.
Despite challenges, it also needs to be said that TD remains in a good spot.
During the recent Barclays Annual Global Financial Services Conference, the company noted that when some smaller U.S. banks went bankrupt, it stood out due to its $150 billion excess deposit position, stable retail deposit base, and strong corporate cash management business.
This allowed TD to weather the storm, support its clients, and consider seizing lending opportunities in a competitive landscape.
Approximately 60% of deposits come from retail checking accounts and low savings products. This stable funding base positions TD to grow its core customer franchise.
Additionally, TD is the third-largest government banking cash manager in the U.S., which supports its deposit base and liquidity. Despite ongoing downward pressure on deposit levels, TD believes that it is in a favorable position for the future.
In general, while the provision for credit losses has increased a bit, the company continues to benefit from a healthy portfolio.
According to the company (emphasis added):
[...] while the Bank has experienced some further normalization of credit performance across key credit metrics this quarter, credit performance remains strong . Accordingly, I continue to expect PCL in 2023 to be in the neighborhood of 35 basis points, which is at the low end of the guidance I provided at the start of the year.
To conclude, TD remains well-positioned , given we are adequately provisioned, we have a strong capital position, and we have a business that is broadly diversified across products and geographies.
The company also enjoys an A-rated balance sheet.
Having said that, TD is doing what it has done so well over the past few decades: expanding its business.
Currently, TD aims to replicate its Canadian success in wealth management in the U.S. by expanding its presence in high-net-worth and mass-affluent markets.
This involves adding financial advisors, building a physical presence in promising locations, and developing specialty teams to cater to high-net-worth clients.
As of 3Q23, the company's wealth management segment has more than CAD 420 billion in assets under management, making it one of the biggest wealth managers in the world.
In fact, it's the biggest institutional money manager in Canada.
TD also holds a 12.4% stake in Schwab ( SCHW ), a strategic relationship that provides opportunities, according to the company.
It's a very important, very strategic relationship for us. We're extremely impressed with that franchise, serves over clients with over $8 trillion in savings. So it's a very important part of our overall financial holdings. I would say that part of that is that we do have a sweep arrangement with Schwab currently at the end of the third quarter, those sweeps totaled about $103 billion overall.
Furthermore, the acquisition of Cowen by TD is seen as a highly complementary move for TD Securities. Cowen's strengths in equity capital markets, equity research, M&A, and mid-market clients complement TD's existing capabilities.
The integration of Cowen's platform is expected to provide TD with a substantial prospect base and opportunities to offer a full range of services to mid-market clients.
Adding to that, after the inability to close the First Horizon ( FHN ) acquisition, TD is pivoting toward an organic growth strategy. TD has a proven track record of organic growth in the U.S., having built its franchise with 10 million clients and 1,200 stores. Now, areas of focus include building the cards business, expanding the wealth franchise, and growing the mid-market business in sectors like healthcare and education.
So, what about the valuation?
Valuation
TD shares are trading at 1.9x the tangible book value. This is below the longer-term median, as investors have fled banking stocks since early 2022.
NY-listed TD shares are down 4.1% year-to-date and roughly 25% below their all-time high.
The current consensus price target is $66, which is 6% above the current price.
I agree with that. However, I cannot make the case that TD is a must-buy right now.
Yes, the yield is juicy, credit quality is strong, and growth initiatives will likely allow the company to maintain satisfying earnings growth.
The problem is that the economy is not in a good spot. Both the Bank of Canada and the Fed are in a spot where they need to incorporate both weakening economic growth and sticky inflation into their policies. This increases the risk that something could break .
So far, credit quality is normalizing. However, that could quickly turn into something worse.
Don't get me wrong, I do not believe that TD is in a bad spot. It will likely keep outperforming its peers due to conservative management and fantastic diversification. I'm just not feeling comfortable getting people into banking stocks. The yield isn't juicy enough to take that risk.
If the market gives us another opportunity, I think waiting for a buying opportunity close to $50 is worth the risk of missing the next rally.
Simply put, I do not believe that the long-term risk/reward is good enough to jump in at current prices - as much as I like the TD business model and its ability to further grow its footprint in key areas like U.S. retail and wealth management.
Takeaway
The Toronto-Dominion Bank offers an attractive dividend yield, consistent growth, and a diversified business model.
Its track record of weathering economic storms and strong capital position make it a solid choice for investors seeking banking exposure.
However, the current economic uncertainty, marked by weakening growth and stubborn inflation, poses risks for the banking sector.
While TD remains well-positioned, the long-term risk/reward may not justify immediate investment.
Despite TD's promising business model and expansion plans, cautious investors may find the current yield not compelling enough to outweigh the uncertainties.
Ultimately, while TD shows potential, a patient approach might be the wisest move in this complex financial landscape.
For further details see:
How Attractive Is Toronto-Dominion's 4.6% Yield?