The Canadian banks have been through some tough times of late. Analysts have grown considerably less bullish over the past year due to a plethora of macro headwinds that are expected to continue to weigh on earnings growth over the intermediate term.
With the Fed poised to slash U.S. interest rates significantly this March, U.S. bank stocks have pulled back accordingly, as lower rates will act to cut into already thin net interest margins (NIMs). On this side of the border, Canadian banks arguably have even more concerns amid the Canadian credit downturn. And given most would agree that the Bank of Canada (BoC) is likely to follow in the footsteps of the Fed, the Canadian banks could be in for more salt in their wounds, with NIMs looking to get sliced even thinner amid an environment where it’ll be tough to sustain meaningful earnings growth.
Moreover, the Canadian banks, on average, are slightly more expensive than that of their U.S. counterparts. And because of this, it’s not a surprise to see short-sellers put some of Canada’s top institutions in their cross-hairs.
Indeed, it’s been a while since the public was this pessimistic on the outlook for Canada’s banks. After all, who wants to pay more to potentially get far less?
While it’s tough to find anything encouraging on the Canadian banks amid their tumble, I am a fan of some Canadian banks after last week’s excessive slide. Consider Toronto-Dominion Bank (TSX:TD)(NYSE:TD), a premium bank stock that’s no longer priced at a premium relative to its peer group. The company recently reported mediocre results in the middle of one of the worst weekly market declines since the Financial Crisis.
Undoubtedly, the slight miss was perceived as horrid, as the appetite for stocks as a whole plunged. But after a more than 9% drop in just a week, I’d have to argue that premier Canadian bank stocks like TD are now severely undervalued, even considering the bleak year-ahead outlook that points to flat earnings growth.
The bar is lowered, and I think Canadian banks like TD are far better prepared to deal with the continued credit downturn than most would give it credit for. TD is no stranger to averting disasters, but this credit downturn, I believe, is far from being a disaster.
The bank posted revenue that was up 6%, and a few more impaired loans in the U.S. caused the provisioning ratio to move above 0.5% — the highest it’s been in quite a while. While more provisioning is likely to continue to be a common theme for Canadian banks through 2020, investors have to be encouraged by loss ratios that are still far from being in a range that’d cause investors to be in a panic.
On a relative basis, TD is doing a decent job of pulling through these challenging times. And although it hasn’t been the best of the Big Six over the last few quarters, from a longer-term perspective, I still think TD is worthy of the highest premium given its long-term risk/reward prospectus.
At the time of writing, TD stock nearly trades at a single-digit forward price-to-earnings multiple (shares currently trade at 10.1 times next year’s expected earnings). That’s not a premium price tag for a bank that I still think is head and shoulders above most of its peers.
The credit downturn will eventually come to an end, and TD will come roaring back, but in the meantime, investors can collect the 4.6% dividend yield at a generationally low valuation as they wait another year or two for credit to slowly normalize and the Canadian economy to bounce back.
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Joey Frenette owns shares of TORONTO-DOMINION BANK.