TD Bank (TSX:TD) is going through a rough ride, with U.S. regulators investigating the American operations for weak processes and controls to prevent money laundering. Contrarian investors are wondering if TD stock is now undervalued and good to buy today for the dividend or if more downside is on the way.
TD stock price
TD has underperformed its large Canadian peers in 2024. The stock is down 11% since the start of January and now trades close to $76. This is about 30% below the peak near $109 in early 2022 that the stock reached before aggressive interest rate hikes in Canada and the U.S. started to scare bank investors.
Risks
Rising interest rates are usually positive for banks as they can boost net interest margins. The steep increase in rates over such a short period of time, however, has increasingly put borrowers with too much debt in a difficult situation as they struggle to cover the higher debt costs. TD set aside about $1 billion in the fiscal second quarter (Q2) 2024 to cover potential bad loans. That’s up from $600 million in the same period last year.
The longer that rates remain elevated in Canada and the United States, the larger the risk that there could be a wave of defaults.
TD’s $1 billion provision for credit losses (PCL) is still very small relative to the size of the total loan book. However, there is a concern that the central banks will have to force a hard landing for the economy to get inflation firmly under control. A surge in unemployment while rates are still high could be problematic for TD and the overall banking sector.
On the operational side, TD’s U.S. issues will likely be a headwind for the stock over the coming months. The bank recently set aside US$450 million to cover potential penalties related to the regulatory investigation going on in the United States. Pundits speculate the fines could go as high as US$2 billion. Again, this sounds like a big amount, and it certainly isn’t good news for shareholders, but TD is sitting on adequate capital to ensure it can ride out the storm.
The larger worry for investors is the potential impact on TD’s growth ambitions in the American market. TD has a significant retail banking business in the U.S., with branches running from Maine down the East Coast to Florida. If regulators decide to restrict TD’s American growth until it has its anti-money-laundering systems fixed, the stock could suffer more.
Opportunity
The stock price might already reflect most of the known and anticipated bad news. Rate cuts on both sides of the border are expected to ramp up through the end of 2024 and into next year as the central banks try to avoid pushing the economy into a deep recession. Easing the pressure on stressed borrowers should result in PCL topping out in the next few quarters. Markets tend to be forward-looking, so there is a chance the bank sector could pick up a nice tailwind like it did last fall when sentiment shifted from fears of more rate hikes to anticipation of aggressive cuts in 2024.
Dividends and buybacks
TD is one of the top dividend-growth stocks on the TSX over the past three decades. The bank remains very profitable and has excess capital on hand, so dividend hikes and share buybacks will likely continue despite the headwinds.
Investors who buy TD stock at the current level can get a 5.4% dividend yield.
Should you buy TD now or wait?
Investors who already own the stock should probably hold on at this point and maybe look to add to the position on additional weakness. It wouldn’t be a surprise to see the stock retest the 12-month low of around $74.
That being said, contrarian investors might want to start nibbling near this level. TD will eventually get the issues in the U.S. business sorted out, and the bank will continue to be very profitable. Any good news that comes out on the investigation front could give TD a new tailwind and drive the stock sharply higher, so investors want to make sure they are ready to capitalize if that happens. In the meantime, shareholders get a good dividend yield to ride out some volatility and wait for the recovery.
If you have some cash to put to work, this stock deserves to be on your radar.
