Royal Bank (TSX:RY) and Enbridge (TSX:ENB) are TSX giants. Investors who missed the rally off the 2020 market crash are wondering if RY stock or ENB stock is now undervalued after the pullback and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio.
Royal Bank is Canada’s largest company, with a current market capitalization of $181 billion. The share price picked up a nice tailwind over the past two months, rising from $120 to $130 per share but is still down from the 2023 high close to $140.
Big and very profitable banks like Royal Bank tend to benefit when investors get nervous about keeping their money in smaller institutions that might not make it through a financial crisis. The failures of a handful of American regional banks earlier this year triggered a wave of deposit flight, and the big boys happily accepted the influx of funds.
Royal Bank’s decision to avoid rushing into the American market in 2021 and 2022 to spend its cash hoard now appears wise. Management’s patience enabled Royal Bank to scoop up HSBC Canada for $13.5 billion, while two of its main Canadian competitors were handcuffed by other deals south of the border.
Bank of Montreal (TSX:BMO) closed its US$16.3 billion purchase of Bank of the West just before the chaos hit the American banking sector. TD Bank (TSX:TD) had to abandon its US$13.4 billion purchase of First Horizon, citing regulatory issues. Share prices of American regional banks collapsed this spring. TD probably dodged a bullet but is now sitting on too much money.
Royal Bank’s HSBC purchase is expected to close in early 2024. Investors should see immediate benefits when that happens.
A deep and prolonged recession triggered by rising interest rates would pressure earnings at Royal Bank and its peers due to rising loan defaults. Royal Bank has the capital to ride out tough times, but commercial and residential property loans are increasingly under scrutiny by investors who think the Bank of Canada is being too aggressive in its efforts to get inflation under control.
At the time of writing, Royal Bank’s dividend provides a 4% yield. The stock trades near 13 times trailing 12-month earnings, which isn’t exactly cheap, given the economic headwinds.
Enbridge (TSX:ENB) might be oversold today after a steep pullback in the past year that has taken the share price from $59 in June 2022 to the current price near $49.
Rising borrowing costs will drive up debt expenses and put pressure on funding for capital projects. However, Enbridge expects adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to increase in 2023, and distributable cash flow on a per-share basis should be roughly in line with last year.
Enbridge is working through a $17 billion capital program to drive revenue and cash flow expansion and has the financial firepower to make strategic acquisitions. The company is seeing opportunities in oil and natural gas exports, renewable energy, carbon capture, and hydrogen. At the same time, the legacy pipeline assets and natural gas utilities deliver steady revenue streams.
Enbridge increased the dividend in each of the past 28 years. The stock now offers a 7.25% dividend yield.
Is one a better pick?
Royal Bank and Enbridge deserve anchor picks in a buy-and-hold portfolio.
At this point, I would probably make Enbridge the first choice for passive income due to the high yield. The stock also offers good upside potential when the energy infrastructure sector rebounds.
Royal Bank has generated good long-term returns for patient investors. The 4% yield is still attractive, and the payout should be very safe. That being said, bank stocks could be in for more turbulence in the next 12 to 18 months, so I would probably wait for the next pullback to buy RY shares.