2023-12-28 06:59:38 ET
Summary
- The Toronto-Dominion Bank hold rating stands the same from August.
- Revenue, earnings, and book value have either declined or are flat, while the market has been pulling up bank stocks above average.
- Proven and stable dividend growth expected to continue.
- Low risk of exposure to office property or underperforming loans.
Stock & Industry Snapshot
Today's research note returns to the financial sector again with coverage of The Toronto-Dominion Bank (TD) (TD:CA).
A few quick company facts include that it offers a full range of financial products and solutions to +$27.5MM customers worldwide, calls itself a top 10 North American bank, is headquartered in Canada at the group level however has a major US business via TD Bank, and shares that trade on the NYSE ((TD)) as well as the Toronto exchanges [TD:CA].
My prior rating of this company in early August called for a hold , and since then the share price has been nearly flat at a slight -0.76% decline, as of today's article.
Relevant to investors in this sector is the recent sector performance from SA market data , which shows that financial services were among the top 3 sectors for 3-year improvement, indicating recent market bullishness on this sector:
For this stock, any earnings data will come from its fiscal 2023 Q4 results that came out on Nov. 30th.
Scoring Matrix
We use a 9-point scoring method that looks at this stock holistically and assigns a total rating score, using a score matrix.
Today's Rating
Based on the score total in the score matrix , this stock is getting a rating of hold.
This is a reiteration of my previous hold rating.
Compared to the consensus rating on Seeking Alpha, my sentiment aligns with the analyst consensus:
Dividend Income Growth
From the dividend growth chart above, we can see the annual dividend went from $1.58 in 2013 to $2.74 in 2022, a 73% growth over 10 years.
If we had bought a hypothetical 100 shares in 2013 it would have went from generating $158 in annual dividend income to $274 only a decade later, and the blue arrow trend line I traced is just the type of steady dividend growth I am looking for in a stock.
My outlook on future growth potential is positive since we already have seen the 2023 annual dividend up to $2.82, if you look at the payments history . In addition, the firm has already declared its next quarterly payout for 2024 at $0.75/share, so we can extrapolate that to be a $3 annual dividend expected for 2024.
In addition, the company continues to be profitable with +$2B in quarterly earnings, so I think this will add tailwind to continued positive dividend growth.
In this category I would call this stock a strong buy , on the basis of proven double-digit dividend income growth in the last decade as well as continued potential growth heading into 2024.
Dividend Yield vs Peers
In the chart above, I am comparing the dividend yield of my focus stock TD vs three banking-sector peers that are also Canada-based but have a large North American market presence. The goal is to pick one of them to add to my portfolio of bank stocks, based on the best dividend yield on my capital invested, if I was a buyer at today's share price.
In this example, we can see that Canadian Imperial Bank of Commerce ( CM ), better known as CIBC, offers the best dividend at +5.23%, while TD trails in third place with a yield of 4.39% . Of this group, Royal Bank of Canada ( RY ) came in last at 3.89% yield.
My outlook on future dividend yield potential is that it may decline somewhat as a bullish market drives financial-sector stocks further up, thereby driving the dividend yield down (as share price makes it more expensive to acquire shares).
So, in this category I would call it a hold rather than a buy, on the basis that a buyer can get a much better yield at two of its peers right now.
Revenue Growth
In this section, we use the income statement to discuss YoY revenue growth.
We can see that in the fiscal quarter ending October, the firm saw $10.01B in total revenue, vs $10.97B in Oct 2022, an 8.7% YoY decline.
Just from looking at the income statement and knowing this sector we see a drivers of these results is the decline in net interest income . In other words, the current rate environment has driven growth in interest income but also growth in interest expense, particularly the cost of money coming from customer deposits. For instance, interest paid on deposits went from $3.85B in Oct 2022 to $8.11B in Oct 2023, a +110% YoY increase in interest expense.
And, while non-interest income from things like trading improved, other non-interest income did not really grow.
From their quarterly presentation, areas of strength included Canadian personal and commercial banking which achieved:
Revenue up 7% YoY; Volume growth and higher margins; Loan volumes up 6%; Deposit volumes up 2%.
However, US retail banking saw 3% YoY revenue declines.
Their wealth management shop saw a 9% YoY revenue growth driven partly by higher fee-based revenue.
My forward-looking outlook on future revenue growth potential is cautiously positive based on continued pressure on net interest margins as policy rates have not come down yet, but may do so in 2024 as implied in the recent Fed meeting. At the same time, with improving equity markets I think this will provide tailwind to fee-based revenue such as managing wealth assets tied heavily to equity portfolios.
We can see from market momentum data, for example, that the 1 year price performance of the S&P500 index has grown to +24.6%.
Hence, my rating in this category would be a hold , on the basis of declining YoY revenue figures and continued pressure on net interest income, offset by potential success tied to rising equity markets and managing wealth of clients.
Earnings Growth
Using the same income statement , we can see that earnings in the October-ending quarter were down to $2.08B, vs $4.89B in Oct 2022, a YoY decline of 57%.
From the firm's quarterly presentation , we can learn that rising expenses are a notable item. For instance, 20% YoY increase in expenses were driven by things like "restructuring charges and acquisition and integration related charges related to the Cowen acquisition, and higher employee-related expenses and variable compensation."
My future outlook on earnings growth sustainability is mixed, and it depends on the company's cost-reduction efforts to succeed. The firm adopted a "restructuring program" late this fiscal year, for instance, with a goal of $400MM pre-tax savings in fiscal 2024. These cost savings "primarily relate to employee severance and other personnel-related costs, real estate optimization, and asset impairments as we accelerate transitions to new platforms"
In this category, I will be giving this stock a sell, on the basis of double-digit earnings declines driven by rising costs, offset somewhat by potential for restructuring efforts to help but this may not be realized until sometime in 2024. What I am looking for in a "buy" potential is a company showing strong YoY earnings growth trends, and this firm's last two quarters saw lower earnings than in April 2023, but particularly lower than Oct 2022.
Equity Positive Growth
Using the balance sheet , we can see that total equity dropped to $80.84B in fiscal Q4 vs $81.76B in Oct 2022, a 1.1% YoY decline in equity. This I would say is practically flat in terms of equity growth, so nothing significant.
If you look at the balance sheet, you will see the firm does not keep that much in cash, but does hold $485.6B in investment securities.
And, besides raising money from customer deposits, it does a bit of corporate borrowing. With the cost of debt the way it is now, my concern is that their long-term corporate debt has gone up to $175.73B vs $114.6B in Oct 2022, a 53% YoY increase in debt. Just to clarify: it is not the "debt" of its customers I am talking about but the company's own corporate debt it borrows in the money markets.
My forward outlook on this company's capital strength continues to be strong, as its data points to a CET1 ratio of 14.4%, and a liquidity coverage ratio ((LCR)) of 130%.
In this category, I will call it a hold , on the basis of relatively flat growth in book value along with rising debt, offset by strong liquidity and capital strength, which I also highlighted in my last rating.
Share Price vs Moving Average
The above yChart compares the most recent share price of $64.95 vs the 200-day simple moving average ((SMA)) of $60.55. We can see the shares are trading at 7.2% premium to the 200 day moving average, and I think this is tied to the bullishness on bank stocks that I mentioned earlier and overall sector recovery from earlier lows.
My job is to decide if this is a buy, sell, or a hold based on a combination of the share price and the other fundamentals I discussed earlier.
In this case, I see a market-driven spike in the share price while earnings and revenue have declined, and equity is flat growth. At the same time, I think the financial sector "rally" is not over yet and has room to grow and could pull this stock up with it.
Evidence of potential for a continued bank rally is highlighted in a mid-December article in Reuters which said the following:
Rick Meckler, partner at Cherry Lane Investments, a family investment office in New Vernon, New Jersey, pointed to the potential economic boost from rate cuts with a strong economy as "a key to bank profitability."
Rallying stock and bond markets will also boost large banks segments including wealth management, capital markets and credit according to Meckler, who also noted that banks are among underperforming sectors "playing catch-up" in the market.
So, I call in this category I call this stock a hold, on the basis of continued share price growth driven by the sector, pulling this stock up with it.
Valuation: Price-to-Earnings
Using valuation data , we can see the GAAP-based forward P/E ratio is now at 11.55, and at a +2.7% premium to its sector average.
What I think is driving this elevated multiple, tying back to the data I talked about earlier, is a combination of the spike in share price along with declining earnings. This is causing a rift between price and earnings and this nearly 12x earnings multiple.
I think the elevated multiple may rise even more as the market keeps pushing up bank stocks, which I expect to continue as mentioned already.
I am not sure that earnings growth will catch up just yet, for the reasons I mentioned in the earnings discussion, so right now I don't think a nearly 12x multiple is all that justified. Consider that its peer CIBC ( CM ) has a better valuation at around 10x earnings, while also having shown YoY earnings growth .
This valuation seems more like a hold than a buy or sell.
Valuation: Price-to-Book Value
Using valuation data , we also can see that the GAAP-based forward P/B ratio is 1.44 and is at a nearly 18% premium in relation to sector average.
In relation to the data discussed earlier, I think this multiple is driven by the bullish share price combined with a flat equity growth, causing this rift between price and book value.
Looking forward, I expect the rift to widen as the market pushes bank stocks up further. What could help drive book value up to catch up with the rising share price would be stronger growth in customer loan assets and growth in the market value of bonds held, driving up total asset values to offset liabilities.
We see from Q3 results that loan volumes in TD's core markets of Canada and the US have shown an increase, so that is a good sign I think.
This multiple of 1.4x book value appears to be a hold more so than a buy or sell, since too overvalued for a great buy right now but also not justifying a sell off either just yet.
Risk Analysis
Two key risks I want to bring up is TD's exposure to impaired loans in relation to its overall loan book, as well as exposure to certain commercial real estate like office properties.
We can see that the company reported an increase in gross impaired loans both in its Canadian and US businesses. However, we can see that the impaired loans-to-overall loans ratio is much lower in the Canada segment than the US one, though both have gone up only slightly on a YoY basis.
In terms of office property exposure, which I have highlighted in several other articles due to reports this year of increasing office default rates, this bank has about 11% of its commercial real estate book exposed to office:
So, I think that both risks present a low potential risk impact and low-to-medium risk probability, especially considering the size and scope of this bank and its capitalization.
With that said, I think this category justifies a buy rating on the basis of a low risk profile, and potential upside if interest rates come down in 2024 which could alleviate some pressure on the cost of borrowing and therefore could reduce the amount of underperforming loans. The latest prediction from Fed rate tracker CME Fedwatch is a 73% chance the Fed will bring down its policy rate after the March meeting.
Quick Summary
To reiterate, I am keeping my hold rating on this stock since August.
Key points driving my neutral sentiment are a share price trading above average while earnings and revenue are on the decline. At the same time, dividend income growth has proven strong, and I expect the sector bullishness to pull up this stock some more.
In this case, my portfolio strategy would be to hold for stable dividend income and growth and expected further price growth, while I think the price is too high to buy new shares now in a company not showing top or bottom line growth.
TD was also on the 2022 list of global systemically important banks , so I also would keep it in a bank's portfolio for that reason, to gain exposure to a very stable and systemically-critical Canada-based bank, particularly if I am also holding a few smaller regional US banks in that same portfolio.
For further details see:
Toronto-Dominion Bank: Helped By Banks Rally But Could Use Earnings Improvement