TD Bank (TSX:TD) is down more than 12% in 2024 and is off about 30% from the all-time high. Contrarian investors are wondering if TD stock is now undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio.
TD share price
TD trades near $75 at the time of writing. This is barely above the 12-month low of around $74 and is way off the $108 the stock reached at the peak of the post-pandemic rally in early 2022.
High interest rates and challenges in American banking operations are responsible for the underperformance of Canada’s second-largest bank by market capitalization.
On the rate front, the impact of high interest rates on borrowers is showing up in the provisions for credit losses (PCL) at all the Canadian banks. TD set aside $1.1 billion in the fiscal second quarter (Q2) of 2024 for potential loan losses compared to $600 million in the same period last year. For the first six months of fiscal 2024, the company reported PCL of $2.07 billion compared to $1.29 billion in fiscal 2023. This sounds like a large amount, and it would be for most companies, but it is very small relative to TD’s overall loan book, which remains in good shape.
That being said, the trend is heading in the wrong direction, and investors are concerned that the U.S. Federal Reserve and the Bank of Canada might have to keep interest rates elevated for an extended period of time to get inflation firmly under control. The risk is that the economy could slide into a recession, and unemployment might spike while rates are still high. In that situation, the banks could see a surge in loan defaults from households and businesses that have too much debt.
TD’s share price is under added pressure due to investigations by U.S. regulators regarding TD’s systems and processes for guarding against money laundering. The bank recently announced it is setting aside US$450 million in an initial provision to cover potential fines connected to the issue. Pundits have speculated the penalties could go as high as $2 billion. Again, this is a big number that shareholders aren’t going to like, but TD is able to cover the hit. The bank finished fiscal Q2 2024 with a common equity tier-one (CET1) ratio of 13.4%. Canadian banks are currently required to have a minimum CET1 ratio of 11.5%, so TD is sitting on ample excess cash.
The larger concern cited by analysts is the unknown potential restrictions that could be placed on TD’s growth initiatives in the American market until the anti-money-laundering investigations are resolved. Markets are not fans of uncertainty, so the situation could prove to be a headwind for the stock over the medium term.
Upside potential
At this point it is possible that most of the pain is already priced into the share price. TD generated solid fiscal Q2 2024 results. Adjusted earnings came in at $3.79 billion compared to $3.71 billion in the same quarter last year, so TD remains a profit machine despite the challenging environment.
Economists broadly expect the Bank of Canada and the U.S. Federal Reserve to start cutting interest rates in the second half of 2024 to avoid pushing the economy into a recession. A soft landing without a spike in unemployment is still the anticipated outcome, so the rise in PCL could level off in the coming quarters and start to decline in 2025 or 2026.
TD will eventually sort out the problems in the American business. In the near term, it will be a distraction for management, and the growth initiative will likely get shelved or delayed. Over the long haul, however, TD should be fine.
Dividends
TD has a great track record of dividend growth over the past three decades, with average annual increases above 10%. The bank raised the quarterly payout from $0.79 per share in 2021 to $0.89 for 2022 after the government lifted the pandemic ban on bank dividend hikes. The dividend rose to $0.96 per share for 2023, and the board bumped it up to $1.02 for 2024.
Investors who buy TD stock at the current share price can get a 5.4% dividend yield.
Should You Buy TD now or wait?
Bank stocks in general could be in for a volatile ride over the coming months if inflation proves sticky around the 3% level and the central banks signal they will keep interest rates elevated into 2025. TD will also likely remain out of favour until there is clarity on how the issues with the American retail operations are going to get solved.
That being said, contrarian investors with a buy-and-hold strategy might want to start nibbling near this level and look to add to the position on additional downside. Buying TD on big pullbacks has historically proven to be a profitable move for patient investors, and you get paid a solid dividend yield right now to ride out the turbulence. If you have some money to put to work, this stock deserves to be on your radar.
