TD Bank: Not A Strong Buy Anymore
Summary
- The financial sector got hit very hard with the coronavirus crisis following record-low interest rates on the one hand and record-high unemployment numbers on the other.
- The COVID-19 impact can also be seen as a giant experiment as to how customers react when they have to mostly rely on mobile and online banking.
- At Toronto-Dominion Bank's current price, there is not much to get excited about the stock given a high degree of uncertainty regarding the economic outlook and the bank's earnings power.
- Still, I continue to view the bank as a core dividend position in my portfolio. Its yield is still very attractive, but the stock is certainly not a strong buy anymore.
Financial stocks have retreated sharply in recent months and staged an almost epic rally thereafter. Even the biggest banks in the U.S. and Canada have seen their stocks drop to levels that we haven't seen for years.
These were golden buying opportunities, no question. However, the reality today is different. The macroeconomic picture has not significantly improved, yet many financial stocks are only moderately below their pre-COVID-19 levels despite a high degree of uncertainty regarding the economic outlook.
One of these is the Toronto-Dominion Bank (NYSE:TD), which dropped as low $34 in March from around $57 but has staged a very strong comeback to its current level of $48.
(Source: Toronto-Dominion Bank, Miami)
At this price, there is not much to get excited about given record provisions for credit losses and a still-damp economic picture despite the surprisingly strong jobs report last week.
What is going on at Toronto-Dominion Bank?
The Toronto-Dominion Bank, as part of Canada's illustrious Big Five (Bank of Nova Scotia (NYSE:BNS), Canadian Imperial Bank of Commerce (NYSE:CM), Royal Bank of Canada (NYSE:RY) and Bank of Montreal (NYSE:BMO)), has a history of uninterrupted dividend payments dating back to the year 1833.
It currently trades at a P/E of 12 and a dividend yield around 4.6%. As other financials, the stock sold off heavily in mid- to late-March, before rebounding and staying in a price corridor. Following a breathtaking post-earnings rally in June, the stock shot up to $48 and is up over 20% over the last month.
Data by YCharts
While the stock markets are always looking forward, the reopening "hopium" expectations have gone too far too quickly, in my view, and investors should not forget about the fundamentals.
The latest results from its Q2 2020 earnings report missed expectations, although that, per se, is not a negative thing given the increased uncertainty around earnings in the first place.
Naturally, the bank recorded significantly lower earnings across its core segments following high loan loss provisions (PCLs) and potential litigation provisions. The table summarizes the development of adjusted net income per main segment:
| Business Segment | Adjusted net income | Q/Q % | Y/Y % | PCL added |
| Canadian Retail | $1,197M | -34% | -36% | $762MM |
| U.S. Retail | $336M | -70% | -72% | $571MM |
| Wholesale Banking | $209M | -26% | -5% | $357MM |
(Source: Company Earnings Release)
Overall, it was a disastrous quarter across all three main segments, with the amount of PCL added during the quarter of $2,299 million substantially higher than total adjusted net income of $1,599. TD's U.S. Retail segment seemingly fell apart during the quarter with a whopping 72% Y/Y decline in net income as PCL alone slashed earnings by 63%. On top of that, as the bank is lapping prior-year quarters where its TD Ameritrade (AMTD) investment did not suffer from zero commissions, this added further losses to the bottom line, with earnings from that investment down 11% Y/Y.
Toronto-Dominion Bank's COVID-19 response
Similar to its peers, TD Bank also provided some insightful commentary and put together some informative slides on its COVID-19 response. The bank's response is purpose-driven and focuses on people, customers and communities.
On the people dimension, TD provided a 2020 COVID-19 job guarantee, enabled mass-scale remote work and handed out extra benefits for those who can't work remotely.
TD's customers could rely on the bank's vast ATM network, which remained fully operational, as well as on a large majority of branches which remained open. On top of that, TD provided payment deferrals on $62 billion in loan balances and increased gross lending exposures to Wholesale Banking clients by $23 billion.
(Source: TD Bank Q2/2020 Earnings Slides)
TD's communities were supported by helping local efforts to manage through COVID-19 and beyond, such as the TD Community Resilience Initiative, by which $25 million is allocated to various projects such as philanthropic efforts, matching grants program or developing solutions to pandemic recovery.
While TD's financial in the quarter are obviously suffering tremendously due to a massive build up in PCL (which we will cover later), the pandemic could also be seen as a large experiment as to how customers will respond when they no longer can have or want physical offline contact.
Apart from macroeconomic factors, the biggest risk I see for banks is the rapid rise of fintechs, especially Square (SQ), which are already rivaling part of the bank's business model by providing credit and payment solutions to their customers. Through the rise of technology, many basic financial products have become commoditized, and customers can easily switch between them. As a result, banks around the world have been busy either forging partnerships with tech companies or acquiring them in order to enhance their digital banking footprint. The current pandemic has now shown for the very first time how customers will react and behave in this new era when it really counts.
Citigroup president Jane Fraser stated:
Banking has changed irrevocably as a result of the pandemic. The pivot to digital has been supercharged
Source: Forbes
TD Bank comes in with an "okayish" rank in Forbes' "The World's Best Banks" list ranking #8 in Canada, i.e., it obviously has a lot more work to do, even though the criteria determining this ranking are not solely based on digital services but also consider attributes like trust, fees and financial advice.
Given the importance of digital adoption, it is crucial to monitor how TD is faring here. In Q2/2020, adoption metrics have unsurprisingly set new records, with a higher share of customers turning to digital services in absolute and relative terms.
(Source: TD Bank Q2/2020 Earnings Slides)
Personally, I was expecting a lot more here. While the charts themselves look impressive with these large green bars in Q2/2020, this is largely the result of a very narrow y-axis whereby even small movements can look rather mighty.
To put that into perspective, although only 60% of Canadian branches remained open during the quarter, this only led to an additional 0.7 million active mobile users (active means a login via a mobile device within the last 90 days).
Management itself was bullish on the digital front claiming "industry leading digital results," but in my view, a lot more needs to be done to shift TD's banking business to digital in future years. TD is certainly on the right track with the investments it has made in omnichannel, but the future of banking technology is evolving rapidly as the number of players in the game is getting bigger and stronger.
A Staggering Rise in Provisions for Credit Losses
For Q2/2020, the bank reported a quarterly increase of PCL by $2,299 million, reaching $3,218 by end of quarter. This sharp increase applied to all segments and major asset classes and is largely related to the COVID-19 pandemic.
(Source: TD Bank Q2/2020 Earnings Slides)
Overall, PCL ratios have now more than tripled within just one quarter, which is something I hadn't even seen during the financial crisis. Given the prevalent uncertainty with respect to duration and severity of the pandemic, it is totally unclear whether PCLs will have to be increased even further or will come down rather sharply in subsequent quarters.
Judging based on how the stock markets have developed, many are expecting a quick V-shaped recovery, which would obviously significantly improve the outlook and allow TD to reduce its substantial PCL levels sooner rather than later.
The big unknown for me is how the pandemic will, or can, affect housing markets in Canada and the U.S. Two of the world's six hottest real estate bubble markets are in Canada - Vancouver and Toronto - according to the latest UBS Global Real Estate Bubble Index study, and if those contract meaningfully following a collapse in demand and an increase of supply during the current recession, that could be an even bigger drag on TD's PCL levels.
(Source: Handelsblatt)
This will be something to watch closely in upcoming quarters, as so far house prices in the Greater Toronto Area, for instance, have only been inching downwards initially despite a sharp drop in sales, but they have already started recovering.
(Source: Toronto Real Estate Trends)
What's in store for dividend investors?
Right now, TD boasts a 4.6% yield and has been growing its dividend by 11% annually over the last 25 years. The latest raise came in Q1 2020 and was a more modest one, with the dividend boosted by 6.8%. That was very prudent action, especially in light of the substantial headwinds the pandemic has created.
Backed by its predictable business model, the company is targeting a payout range between 40% and 50%, as it has currently positioned itself at the lower end of that range with a payout ratio in the low-40%'s range. So, the bank is well-positioned for further dividend growth in the future. I wouldn't be surprised if it would exceed its target payout range in 2020, as management is very committed to the dividend, even if earnings may take a heavy hit.
Earnings, obviously, always matter, and TD is running stress tests on its liquidity and capital positions. Right now, it is too early to say what type of adverse scenario will materialize and how quickly the reopenings and recovery will lift earnings in the next quarters.
And it's hard to predict it perfectly, but we will be checking in very, very regularly to see how that plays out. The other thing I would add is that one of the hallmarks of TD, one of the strengths of TD is that we will adapt to the environment we find ourselves in.
Source: TD Q2/2020 Earnings Call
In the end, it all boils down to whether the massive PCL build up in the quarter is something that will continue or whether it already covers sufficient downside. In my view, TD will do whatever possible to maintain the dividend at least, and even an additional similarly disastrous quarter as the most recent one - although I am not expecting it - should still allow the bank to keep the dividend streak intact.
The stock is currently yielding 4.6%, which is not a juicy bargain anymore but still very attractive for long-term investors. The bank has recently declared its next dividend, with the stock going ex-dividend on July 9 with dividend payment set for July 31. The snapshots below are taken from my newly and free-for-all released Dividend Calendar (make sure to follow instructions in the video) and show the next expected ex-dividend dates and payouts for the Toronto-Dominion Bank.
(Source: My Dividend Calendar)
Investor Takeaway
We have seen the bottom in stocks in mid-March, and while the massive rebound was unexpected, so was the heavy sell-off, as eventually, nobody really knew or knows how to price stocks in times of a pandemic when previous unemployment records are shattered and unprecedented federal aid and liquidity is poured into the system.
TD Bank, like all other banks, build a boatload of PCL during the quarter, and as a result, has seen its earnings collapse. This is certainly not the new normal earnings power for TD Bank, but it is uncertain what impact the current reopenings and recovery steps will truly have on the next quarter's earnings.
There was nothing to get excited about during the most recent quarter, but I continue to view TD Bank as a core dividend position in my portfolio. Its yield is still very attractive, but the stock is certainly not a Strong Buy anymore. I am adding to it via my monthly investment plan, but that is about it for now, as there are still too many uncertainties left in order to truly assess if the strong rebound in its stock price is warranted or has occurred far too quickly.
I am closing with a statement from TD's press release:
Given the high degree of uncertainty related to the progress of the pandemic and its effects on the economy, the risks around the outlook are larger than usual.
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This article was written by
Analyst’s Disclosure: I am/we are long TD, BNS, RY, CM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I am not offering financial advice but only my personal opinion. Investors may take further aspects and their own due diligence into consideration before making a decision.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (15)
I love how you expressed that! Yep, long all 3, also....
