Royal Bank (TSX:RY) and Enbridge (TSX:ENB) have seen their stock prices drop over the past year. Investors who missed the rally off the 2020 market crash are wondering if ENB stock or RY stock is now undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) focused on dividends and total returns.
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Royal Bank
Royal Bank is the largest company on the TSX with a current market capitalization near $170 billion. The stock trades below $122 per share at the time of writing compared to nearly $140 in February.
The choppy decline over the past seven months is due to investors trying to decide if soaring interest rates will trigger a severe recession. The Bank of Canada and the U.S. Federal Reserve are working to get inflation back down to their 2% target. To do this, they need to cool off the economy and loosen up the tight jobs market. Increasing interest rates is the tool they prefer to use to achieve the goal. Companies tend to reduce investment in new projects when debt costs are too high. At the same time, the steep rise in mortgage expenses forces households to reduce consumption of non-essential goods and services.
Economists widely expect the economy to go through a short and mild recession before the central banks ease up on rate hikes. There is a risk, however, that the central banks will push rates too high and keep them elevated for too long. If that turns out to be the case, the economy could go into a severe slump, and unemployment could surge. Businesses and households that are carrying too much debt could then default on loan payments. If things get really ugly, the banks could be in for a rough ride.
At this point, the drop in the share price of Royal Bank might be overdone, even considering the economic headwinds. The company reported solid fiscal third-quarter (Q3) 2023 results, with adjusted net income coming in at $4 billion for the quarter. That’s pretty good for three months of operations. Adjusted return on equity (ROE) remains high at 15.1%, and Royal Bank has adequate capital on hand to cover its pending acquisition of HSBC Canada and remain above the regulatory requirements. In the latest quarter, Royal Bank set aside more cash to cover potential bad loans compared to the same period last year, but the overall loan book remains solid.
Royal Bank raised the dividend earlier this year. At the time of writing, the stock provides a 4.4% dividend yield.
Enbridge
Enbridge is also a TSX giant with a current market capitalization of nearly $96 billion. The stock trades close to $47.50 at the time of writing compared to $59 in June 2022. The drop is largely due to the broader pullback in the energy infrastructure sector. Enbridge and its peers have large capital programs with projects that take years to complete. They use debt as part of their funding strategy, so higher interest rates make borrowing more expensive. This puts pressure on profits and can impact the cash flow available for distributions.
Enbridge’s $17 billion capital program, along with potential tuck-in acquisitions, should drive steady revenue growth in the coming years. The company’s pipeline, export, utility, and renewable energy assets generate steady cash flow to support the dividend. Enbridge raised the distribution in each of the past 28 years. At the time of writing, investors can get a dividend yield of 7.5%.
Is one a better pick?
Royal Bank and Enbridge both deserve to be anchor stocks for buy-and-hold investors. For a TFSA targeting passive income, Enbridge is probably the best choice today. Royal Bank might be better for RRSP investors looking to generate higher long-term total returns.
