The plunging loonie was one of the biggest stories of 2015—the loonie was the worst-performing major currency (next to the Mexican peso) and is sitting at 11-year lows after plunging 28% in the past three years.
Looking out to 2016, analysts seem to agree—the loonie is set for further depreciation against the greenback. In 2015 the loonie averaged US$0.78. For 2016, analysts are forecasting an average of about US$0.72 for the year. For Toronto-Dominion Bank (TSX:TD)(NYSE:TD) investors, this is good news.
This is because TD has $2.5 billion (representing 29% of total net income) coming from its U.S. retail segment, and the weakening loonie in 2016 will only amplify the strong U.S. dollar growth the segment is expecting. In addition to this, the weakening loonie also offers TD several other perks. Here are the key benefits that shareholders need to know.
1. TD will benefit as U.S. earnings are translated into Canadian dollars
Perhaps the best way to see how depreciation of the loonie will affect TD in 2016 is to look at what it did in 2015. TD’s major source of U.S. earnings is its U.S. retail segment, and this segment grew earnings by about US$115 million (6%) in 2015.
Since TD reports in Canadian dollars, however, these earnings needed to be translated back to Canadian, and in Canadian dollar terms TD’s U.S. segment saw earnings grow by about $437 million.
This means that about $322 million of this growth can be attributed to changes in currency, and this translates to about $0.17 per share. This equals 3.7% of TD’s 2015 earnings.
This is a sizeable uplift, and currency contributed about half TD’s overall net income growth in 2015. This year should see also see a large boost.
With TD’s U.S. segment expected to see 9% growth in U.S. dollar terms in 2016 and the loonie expected to depreciate against the U.S. dollar by a further six cents, TD can expect to see a major net income contribution from its U.S. segment.
The weakening loonie will only amplify the solid growth already coming from the U.S. segment, pushing the U.S. segment’s percentage growth well into the double-digits in Canadian dollar terms. TD estimates that a one cent depreciation in the loonie will add about $32 million to earnings, meaning TD can expect an approximately $200 million increase due to currency.
2. Further weakness is a hedge against lower oil prices
TD Bank investors and Canadian bank investors in general are often concerned about the effect of oil prices on bank earnings, and rightfully so in many cases—banks are exposed to oil prices directly through loans to the oil and gas sector and indirectly through consumer credit in the regions that are affected by oil prices.
When a borrower stops making timely payment or the bank suspects there is a risk of default, they must put money aside to compensate for this risk by making a charge against their earnings known as a provision for credit loss (PCL).
This reduces earnings, and TD estimates that in the event of oil dropping to $35 per barrel and gradually increasing over several years, TD would see its PCLs grow by 5-10% per year from current levels (about $1.6 billion in 2015).
Fortunately, as oil prices fall, the Canadian dollar also falls. This means that because of TD’s large U.S. earnings base, it is able to effectively offset some of the increasing PCLs that come with falling oil prices.
3. TD will also see a boost to its book value per share
Like TD’s U.S. net income, the value of TD’s U.S. net assets also need to be translated back into Canadian dollars. This means that the bank’s shareholder’s equity, or book value, will be higher.
Some investors choose to value a bank based on price-to-book ratios (share price divided by book value per share), and a higher book value could make TD appear more undervalued relative to its peers.
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Fool contributor Adam Mancini has no position in any stocks mentioned.