Bank of Nova Scotia (TSX: BNS) and Enbridge (TSX: ENB) have traded at prices well below their highs in the past two years and now offer attractive dividend yields. Contrarian investors are wondering if BNS stock or ENB stock is undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio.
Bank of Nova Scotia
Bank of Nova Scotia trades near $64.50 at the time of writing. The stock is up nearly 14% in the past six months, but is still way off the $93 it hit in early 2022.
The five-month rebound that occurred through the end of last year and first quarter of 2024 came as a result of a shift in market sentiment on interest rates. Investors that sold bank stocks as interest rates increased in 2022 and 2023 started to bet that rate hikes are finished and began positioning for rate cuts in 2024.
In recent weeks, however, indications of sticky inflation above 3% in the United States and near 3% in Canada led to a pullback. Investors should expect ongoing volatility to continue until there is clear evidence that inflation is headed back to the 2% target and the central banks are going to start to cut rates.
Bank of Nova Scotia and its Canadian peers increased their provisions for credit losses (PCL) in recent quarters as more customers with high debt levels struggled to pay their loans. The longer rates remain elevated, the higher the risk that there could be a sharp downturn in the economy, which would put added pressure on businesses and households. Falling revenues at businesses could lead to a surge in unemployment and trigger a wave of mortgage defaults.
Risks remain in the near term, but BNS stock is probably undervalued if you look out four or five years. The bank remains very profitable and economists broadly expect a soft landing for the economy as the central banks start to reduce interest rates.
Investors who buy BNS stock at the current level can get a 6.6% dividend yield.
Enbridge
Enbridge is up about 10% in the past six months and currently trades near $48.50 per share. The stock was as high as $59 in 2022, so there is still decent upside potential when interest rates start to decline.
Enbridge uses debt to fund part of its growth program, which includes a mix of capital projects and acquisitions. Higher borrowing costs caused by the jump in interest rates over the past two years is eating into profits.
However, Enbridge expects the $25 billion capital program and benefits from US$14 billion in acquisitions in the United States to drive growth in earnings before interest, taxes, depreciation, and amortization (EBITDA) of 7% to 9% annually over the next two years. Distributable cash flow (DCF) should increase by 3% per year until 2026 and 5% annually afterwards.
This should support ongoing dividend increases in the 3%-to-5% range. Enbridge raised the dividend by 3.1% for 2024 and has increased the distribution for 29 consecutive years. At the time of writing the stock provides a 7.5% dividend yield.
Is one a better pick?
Bank of Nova Scotia and Enbridge pay attractive dividends that should continue to grow. Investors seeking the highest dividend yield for a TFSA targeting passive income should go with Enbridge, while contrarian RRSP investors seeking a good dividend yield and a shot at meaningful capital gains in the coming years might want to make BNS the first pick right now. I would probably split a new investment between the two stocks at the current prices.
