Why Invest in Canadian Stocks?
While the S&P500 rallied over 23% YTD, the TSX Composite index only rallied 6% YTD. The huge underperformance of the TSX is due to its heavy weighting towards material stocks which experienced massive declines due to lower commodity prices. However, given the underperformance Canadian stocks, the outlook in the next 6-12 month is much brighter. As outlined in a general market outlook report I wrote, equities will benefit from the accommodative policy from the Fed. QE is positive for commodity prices, which lead to additional inflows into Canadian stocks.
This article provides a yield pick that has solid dividends and trade at attractive multiples for the typical defensive investor.
The Best Play in Canada's Bank Stocks:
About The Company:
Toronto Dominion Bank (TD), often called TD by its customers and investors, is the second largest bank in Canada by market capitalization. TD has 4 main divisions: (1) Canadian Retail Banking (2) U.S. retail banking (3) Wholesale banking/Capital markets (4) Wealth management and insurance. TD generated 48% of its total earnings from Canadian retail banking, 21% from U.S. retail banking, 12% from wholesale banking and 19 from wealth management and insurance. TD's main growth plan is to expand its U.S. retail banking business. TD has more branches in the U.S. than Canada, covering the entire eastern states from Maine to Florida. TD's U.S. business grew through the $8.5 billion acquisition of Commerce Bank in 2007 and the $4 billion acquisition of Banknorth in 2004.
The underlying investment thesis in TD is its compelling growth potential in the U.S., lower valuation vs. peers and excellent retail brand. TD provides unparalleled customer service to its retail clients and has won many awards for its outstanding customer service including Sunday and late-hour banking. A strong customer base in its retail operations has provided TD with stable revenues and earnings even in the 2008 crisis. TD has the lowest earnings volatility among the Canadian banks during the last 8 quarters, but it is not fully reflected in the stock price. TD trades at 10.6X 2014 earnings, one of the cheapest banks based on forward earnings. The bank faced a large charge in Q3 (Quarter ending July) because insurance charges relating to the Alberta floods and slower than expected loan growth in its U.S. retail business. However, based on earnings reported by U.S. banks like Wells Fargo (WFC) and JP Morgan (JPM), the underlying credit condition is healthy in the U.S. and loan growth is still robust, which will be beneficial for TD when it reports Q4 earnings (Quarter ending October) in November. The author believes TD's management can transform its U.S. retail business similar to its Canadian franchise, albeit not at the same profitability level because its Canadian business benefit from an oligopoly market structure. TD's Canadian retail banking business earns a 50% ROE while its U.S. business is hardly achieving a 10% ROE. TD's management has guided for further consolidation and increased efficiency in its U.S. business which will enhance ROE in the future.
The author's intrinsic value estimate of TD is based on a valuation range of $100-$105, which is 2-2.1X the current book value of $50.03. TD has traded significantly above 2X book before the 2008 crisis and could trade at that premium multiple again if it can demonstrate further growth in its U.S. retail banking business. The mid-point of the valuation range, $102.50, is 10.3% higher than the current share price of $93. For U.S. investors, the price target is in Canadian Dollars because its reporting and functional currency is in Canadian Dollars. The $100-$105 valuation range translates to a price range of $96.15-100.96 for TD's NYSE listed shares using today's USDCAD exchange rate of 1.04. Investors should not forget that the stock is yielding 3.6% and TD has the best potential to raise its dividend further because the current dividend payout is near the lower end of its targeted payout range. TD has achieved a 10.5% compounded dividend growth rate in the last 20 years compared to the 9.7% average dividend growth rate provided by other Canadian banks and it is best positioned for additional dividend growth in the future.
For a more comprehensive article on Canadian banks, please see the author's prior article on the topic.
Table 1: TD Quick Facts
|Dividend Yield (Current)||3.6%|
|Trailing P/E (Trailing 12M)||12.8X|
|Forward P/E (FY 2014)||10.6X|
|P/B (Most Recent Quarter)||1.83X|
|P/TVB (Most Recent Quarter)||2.78X|
|ROE (Average Last 4 Quarters)||15.2%|
Basel III Tier 1 Common Equity Ratio (Most Recent Quarter)
|Efficiency Ratio (Average Last 4 Quarters)||58.9%|
Source: Company Q3 Report. Basel III Tier 1 Common Equity Ratio is a capital ratio based on Basel III rules set by the Basel Banking Committee. The Efficiency Ratio is calculated as non-interest expense dividend by total revenue.
Additional disclosure: This article is for informational purposes only and does not constitute an offer to buy or sell any securities discussed in the article. The stock mentioned in this article does not represent financial advice. The target price presented in this article are based on current information and are subject to change without further notice. Investors are recommended to conduct further due diligence before committing capital to any investment