BCE (TSX:BCE) and Bank of Montreal (TSX:BMO) trade at prices that are way below their 12-month highs. Investors who missed the rally off the 2020 crash are wondering if BCE stock or BMO stock is now undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) focused on passive income.
BCE
BCE trades near $55.50 at the time of writing. The stock is near its 12-month low and down from $65 in early May.
The big drop over the past four months is largely due to the ramp up of rate hikes by the Bank of Canada after the central bank paused at the beginning of the year. Higher interest rates make existing variable-rate debt more expensive and also tend to push up the yield investors require to lend money to companies.
BCE uses debt as part of its financing strategy to pay for capital projects such as the expansion of the 5G network and the running of fibre optic lines to the premises of its customers. These are capital-intensive programs that should drive higher revenues while helping BCE protect its competitive position in the market. However, the steep jump in borrowing costs puts pressure on profits and can reduce cash flow available for distributions.
BCE is also seeing a drop in ad spending across the legacy media assets, including radio and television. Customers are cutting back on marketing budgets and shifting to digital media options. The headwinds will likely persist, and BCE has trimmed headcount this year to adjust.
Interest rate hikes should be nearing their peak. As soon as the Bank of Canada indicates it has achieved its objective of getting inflation under control, rates are expected to decline, and that should put a new tailwind behind BCE’s share price.
The company expects total revenue and free cash flow to grow in 2023, driven by ongoing strength in the mobile and internet businesses. This should help support the dividend. BCE increased the dividend by at least 5% in each of the past 15 years. At the time of writing, the stock provides a 7% dividend yield.
Bank of Montreal
Bank of Montreal trades for close to $119 per share at the time of writing. It was as low as $111 last month but is still down from the $136 level it reached in February after announcing the closing of a major acquisition.
Bank of Montreal purchased California-based Bank of the West for US$16.3 billion. The purchase added more than 500 branches to BMO Harris Bank, the U.S. subsidiary, and gives Bank of Montreal a strong presence in the California market.
Unfortunately, the meltdown in the share prices of regional U.S. bank stocks occurred shortly after Bank of Montreal closed the purchase. Failures of high-profile regional banks sent the segment into a tailspin, and most regional bank stocks remain under pressure. Investors might be concerned that Bank of Montreal paid too much for the purchase. Time will tell, but the company should see long-term benefits from the deal.
Bank of Montreal paid its first dividend in 1829 and has given investors a slice of the profits every year since that time. The current yield is 4.9%.
Is one a better pick?
BCE offers the higher yield right now, and the stock appears oversold. Investors focused primarily on passive income might want to make the communications giant the first pick. That being said, Bank of Montreal also looks cheap and should deliver better dividend growth over the long run. Investors seeking total returns should put BMO stock on their radar.
