Toronto-Dominion Bank (TSX:TD)(NYSE:TD) has been a fantastic investment for both dividend growth and capital appreciating in the past few years, but the outlook for 2015 and beyond has the market a bit concerned.
The full-year results for fiscal 2014 were rock solid. For the year ended October 31, Toronto-Dominion increased overall earnings by 8%. The company finished the year with a Basel III capital ratio of 9.4%, and dividends increased by 14% during the year. Total shareholder return for 2014 came in at a respectable 20%.
While the full-year results were solid, the Q4 numbers were weaker than expected. The market should not have been surprised at this because management gave investors an early heads-up when it reported the Q3 results.
During the Q3 conference call, Bharat Masrani, the new CEO, told analysts that heightened competition for loans was putting pressure on margins. When the Q4 results came out in early December, the market reacted negatively.
On the Q4 conference call, management again warned the market that the company was facing some headwinds heading into 2015.
Let’s take a look at the current situation to see where the risks and possible positive surprises are for this year.
U.S. operations
TD has invested heavily in building a huge banking operation in the U.S. where it now operates more than 1,300 branches. While investment in the U.S. operation is slowing, TD still expects to open 23 new stores in the U.S. in 2015.
Low interest rates and increased competition continue to pressure margins in the U.S. unit. Earnings in 2014 benefitted from a big move in the U.S. dollar. The U.S. dollar continues to gain strength and this should help support earnings even as some of the other 2014 tailwinds fade.
Canadian operations
Canadian customers continue to support growth at the company. TD is still seeing strength in lending, credit card use, insurance, and wealth management.
As long as interest rates remain low and Canadians stay employed, the debt binge will continue. Lower gasoline and natural gas prices should mean Canadians have more net income available to invest, pay other bills, or more likely, spend using their credit cards. This could provide extra support to TD’s earnings and offset some of the margin pressure.
At the same time, there are valid concerns that Canadians are reaching a point where they might not be able to handle much more debt, and an unexpected economic shock or increase in interest rates could spell trouble for Toronto-Dominion and the other banks.
Energy exposure
In the Q4 conference call, Mark Chauvin, TD’s chief risk officer, told analysts: “At present, we would not expect to see any material loan impairment or losses in an environment where oil dropped to $60 for an extended period. Historically, our experience with this sector has been very good. For context, we incurred no credit losses in the 2008/2009 financial crisis during a period in which oil prices touched $35.”
Expenses
Toronto-Dominion is committed to improving its industry-leading customer service. The entrance of non-bank competitors into the digital payments space is a concern for all of the Canadian banks, and Toronto-Dominion has to invest in this space in order to remain capable of offering its customers payment solutions that are as secure and flexible as any technology in the market.
In order to preserve earnings and still improve customer service, the bank will probably start cutting expenses in areas that are not performing well. Investors shouldn’t be surprised if TD makes some restructuring announcements this year.
Should you buy?
Toronto-Dominion is a solid long-term investment, but the company is warning that it might not hit its target of 7% to 10% earnings per share growth in the medium term. As such, dividend growth rates will probably be less robust in 2015 and the shares might continue to drift lower through the first part of the year. At this point, the company is probably a hold.
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