What Does the Recession Mean for Toronto-Dominion Bank Investors?
Earlier last week, Statistics Canada came out with the highly anticipated GDP numbers for the second quarter of 2015, and the results were poor—the Canadian economy shrunk by -0.5%, preceded by -0.8% in the first quarter. These results are significant because a recession is technically defined as two quarters of consecutive declines.
For Toronto-Dominion Bank (TSX:TD)(NYSE:TD), this is certainly news to take note of. Canadian banks are highly dependent on the success of the Canadian economy, since GDP growth drives employment growth and spending, which in turn drives appetite for credit, investments, and capital markets activity. In a slowing economy, people borrow less and focus on paying down debt, which can harm bank earnings.
Does this mean current or potential TD Bank shareholders should be concerned? For the most part, the answer is no. Here’s why.
The “recession” is unlikely to be a real recession
This may seem confusing, since the definition of a recession is two quarters of consecutive declines in GDP. While this is the technical definition of a recession, many economists agree that the recent numbers from statistics Canada are far more indicative of a period of stagnation or weakness rather than a proper recession.
There are several reasons for this. Firstly, most economists are expecting GDP to return to positive growth in this current quarter, with the consensus among economists being that GDP will grow 2.5-3%. Traditionally, recessions are characterized not only by fairly deep GDP losses (as opposed to the reasonably flat results for the first and second quarters) as well as length. With the economy set to improve in third quarter, this would be a very mild and short recession if it were one.
Most importantly, however, is the fact that economic weakness was largely confined to drops in business investments from the energy sector as capital projects were shelved. Outside of this, employment grew in both quarters, consumer spending was up 2.3%, and housing was up 1.3%. Since the beginning of the year, the Canadian economy has added 115,000 new jobs and total hours worked in August saw the highest single month gain since August 2010.
While the weakness in the oil sector is a headwind for TD Bank, the measures that count—consumer spending, hours worked, employment, and strength in the housing market—are all positive for TD Bank. While conditions are far from ideal economically while commodity prices stay weak, the biggest concern for TD Bank is likely just a more conservative growth forecast.
This conclusion is reflected in TD’s results for the recent quarter. TD Bank beat earnings estimates, and saw profits increase by 7.5%. In fact, TD Bank has beat analyst estimates for the past three quarters.
If the economy does worsen, TD is well prepared
What if the economy does take a turn for the worse? TD Bank benefits from strong geographic diversification, low energy sector exposure, and strong credit quality and capital ratios, all of which will help insulate the bank to an extent.
TD Bank’s strongest protective factor—and growth-driver—is its large U.S. exposure through it’s American retail segment. About 33% of TD Bank’s revenue comes from the U.S., along with 29% of net income. TD Bank’s American segment not only protects a portion of TD Bank’s earnings from commodity-related weakness and overall softness in the Canadian economy, but it also serves as a growth engine.
Firstly, U.S. GDP growth is expected to be much higher than Canadian GDP growth going forward. Due to the fact that the U.S. is experiencing stronger growth and American consumers have much lower debt levels, TD Bank’s U.S. segment should see much stronger loan growth than Canada.
In addition, the weaker Canadian dollar means that TD Bank’s U.S. earnings are worth much more when translated back into Canadian dollars, with each $0.05 increase in the CAD/USD exchange adding 1% to earnings per share.
With interest rates in the U.S. expected to rise shortly, TD can also expect to see better margins from its U.S. segment. The end result is TD Bank’s business model is poised to perform well in the current economic climate, and investors should consider the latest pullback as a buying opportunity.
Do you own shares in TD or any other Canadian bank? You won't want to miss our latest report!
Canadian banks are considered must-have investments. After all, they're very stable, well capitalized, and face limited competition. That said, there are concerns for the banks and their investors. In this FREE report, we cover everything you need to know about Canada's Big Five--whether you're already an investor or are considering buying shares. Simply click here to receive your special FREE report, "What Every Bank Shareholder MUST Know."
NEW! This Stock Could Be Like Buying Amazon In 1997
For only the 5th time in over 14 years, Motley Fool co-founder David Gardner just issued a Buy Recommendation on this recent Canadian IPO.
Stock Advisor Canada’s Chief Investment Adviser, Iain Butler, also recommended this company back in March – and it’s already up a whopping 57%!
Enter your email address below to claim your copy of this brand new report, “Breakthrough IPO Receives Rare Endorsement.”
Fool contributor Adam Mancini has no position in any stocks mentioned.
Earlier last week, Statistics Canada came out with the highly anticipated GDP numbers for the second quarter of 2015, and the results were poor?the Canadian economy shrunk by -0.5%, preceded by -0.8% in the first quarter. These results are significant because a recession is technically defined as two quarters of consecutive declines.
For Toronto-Dominion Bank (TSX:TD)(NYSE:TD), this is certainly news to take note of. Canadian banks are highly dependent on the success of the Canadian economy, since GDP growth drives employment growth and spending, which in turn drives appetite for credit, investments, and capital markets activity. In a slowing economy,…