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TD Bank (TSX:TD) recently hit a low not seen in more than three years. 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 focused on dividends and total returns.
TD share price
TD trades near $75 at the time of writing. The stock is down more than 12% in 2024 and remains significantly below the $109 it hit in early 2022 at the peak of the rally that occurred after the 2020 market crash.
Interest rate hikes in Canada and the United States have driven a lot of the volatility in the bank sector over the past two years as investors worried that the central banks would have to push the economy into a recession in order to get inflation under control. At this point, economists appear to be broadly of the opinion that the economy will see a soft landing. The Bank of Canada already cut interest rates and is expected to continue the downward trend through next year. In the United States, inflation remains above 3%, so the Federal Reserve might decide to wait until 2025 before it begins to lower rates.
The labour market is holding up well, so there shouldn’t be a tidal wave of loan defaults caused by high rates. That being said, TD and its peers have been raising provisions for credit losses (PCL) in recent quarters as more customers struggle to cover the jump in borrowing costs. TD booked PCL of $1 billion in the fiscal second quarter (Q2) 2024 compared to $600 million in the same quarter last year. PCL should level off in the coming months and begin to decline in 2025, as long as there isn’t a surge in unemployment.
U.S. challenges
TD’s larger issues relate to troubles in its American business. The bank operates more branches south of the border than it does in the domestic market after 20 years of acquisitions running from Maine right down the East Coast to Florida.
Regulators are investigating TD for having weak systems in place to detect and prevent money laundering. TD recently set aside US$450 million to cover potential fines. Analysts think the total penalties could come in at US$2 billion to U$4 billion, depending on the outcome of the investigations. In addition, pundits speculate that TD could be forced to shelve its growth ambitions in the United States until it can prove to regulators that it has fixed the issues. This could weigh heavily on revenue and earnings growth over the medium term. In the coming quarters, TD will likely have to spend significantly to get its systems up to speed, and the situation will be a distraction for senior management.
Markets don’t like uncertainty. Until there is some clarity on the outcome of the U.S. situation, TD stock will likely remain under pressure.
Upside
An argument could be made that most of the anticipated bad news is already priced into the stock. Any positive developments could send the share price meaningfully higher in a very short time.
TD remains very profitable despite the challenges. The bank generated adjusted net income of $3.8 billion in fiscal Q2 2024 compared to $3.7 billion in the same period last year. TD finished fiscal Q2 with a common equity tier-one (CET1) ratio of 13.4%. Canadian regulators require a CET1 ratio of 11.5%, so TD is sitting on meaningful excess cash. This will help TD cover potential fines in the U.S. while providing liquidity to maintain dividend growth or buy back shares.
At the time of writing, TD stock provides a 5.45% dividend yield.
Should you buy TD stock now?
The trend isn’t your friend right now, and more downside could be on the way. If the broader equity market goes through a correction, it wouldn’t be a surprise to see TD dip to $70 in the coming months.
That being said, TD stock already looks cheap and offers a good dividend yield to ride out the volatility. 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 weakness. Over the long haul, TD investors should do well.
The bank will eventually get the issues in the American business sorted out. As we saw last fall, bank stocks can move significantly higher on a shift in market sentiment.
