Expectations of additional interest rate cuts in Canada are providing a tailwind for many TSX dividend stocks that sold off in 2022 and 2023 when the Bank of Canada aggressively increased interest rates to get inflation under control.
Investors who missed the bounce off the lows are wondering which Canadian dividend stocks are still undervalued and good to buy for a self-directed Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) portfolio.
Fortis
Fortis (TSX: FTS) is a Canadian utility company with $69 billion in assets spread out across Canada, the United States, and the Caribbean. The stock fell from $65 in 2022 to as low as $50 in the past year as investors bailed out of utility stocks due to rising borrowing costs. Fortis uses debt to fund part of its growth program. Rising debt expenses cut into profits and can reduce cash that is available for distributions to shareholders.
The stock is up about 10% in the past month after two consecutive rate cuts by the Bank of Canada. Markets expect the U.S. Federal Reserve to start cutting interest rates as early as next month. That should provide an extra boost for the utility sector heading into 2025.
Fortis is working on a $25 billion capital program that will increase the rate base from $37 billion to $49.4 billion over a five-year period through 2028. As the new assets go into service, the additional revenue and cash flow should support planned annual dividend increases of 4-6%. Fortis raised the dividend in each of the past 50 years, so investors should feel comfortable with the guidance.
At the time of writing, investors can get a 4% yield from FTS stock. A near-term pullback is possible, given the size of the run in recent weeks. However, the long-term outlook should be positive, and it wouldn’t be a surprise to see the stock trend up to the 2022 high by the end of next year.
Bank of Nova Scotia
Bank of Nova Scotia (TSX: BNS) trades near $62.50 at the time of writing. The stock is up from the 12-month low near $55 it hit last fall but is still way off the $93 it reached in early 2022.
Banks normally benefit from rising interest rates due to the boost they get on net interest margins. The sharp rise in rates that occurred over such a short period of time, however, put borrowers with too much debt in a difficult situation in the past two years. Bank of Nova Scotia and its peers have significantly increased provisions for credit losses (PCL) as a result. The recent reduction in rates in Canada will immediately help borrowers with variable-rate loans. The drop in rates on fixed-rate mortgages will ease some of the pain for homeowners who bought when rates were very low and now have to renew the mortgages as they come due.
It will take some time for the impact of the rate cuts to work through the system, but investors should see PCL start to level off in the next few quarters. Banks might even be in a position to make PCL reversals if the economy experiences a soft landing and struggling borrowers default at a lower level than anticipated.
Bank of Nova Scotia continues to invest for long-term growth. The bank recently announced a US$2.8 billion deal to take a stake of nearly 15% in KeyCorp, a U.S. bank. The deal surprised investors, and the market initially reacted negatively to the move, but the bet gives Bank of Nova Scotia a foothold in the U.S., where it plans to grow as part of the strategy shift implemented under the new chief executive officer who took over last year.
Investors will need to be patient, but BNS stock already looks cheap and you get a decent 6.8% dividend yield at the current share price.
The bottom line on top TSX dividend stocks
Fortis and Bank of Nova Scotia pay attractive dividends that should continue to grow. If you have some cash to put to work in a portfolio focused on dividends, these stocks deserve to be on your radar ahead of anticipated rate cuts in the United States and additional rate cuts in Canada.
