Company Profile

Toronto-Dominion Bank (TSX: TD) is a Canada-based banking group. It is the sixth largest bank in North America by total assets, with a customer base of more than 26 million scattered around the globe. The bank has more than 13 million active digital customers with more than 6000+ ATMs. Further, the bank has more than 2,300 retail locations across North America. The bank's operating segments are divided into three broader categories, including Canadian Personal and Commercial Banking, U.S. Personal & Commercial Banking and Wholesale Banking. At the end of Q2FY20, the bank's 55% to the total earnings came from Canadian operations, 31% from U.S. Retail, 5% from wholesale banking and 9% from TD AMTD.

Investment Rationale

• Strong Balance Sheet and Capital Position: At the end of Q2FY20, the bank’s balance sheet remained solid with Common Equity Tier-1 (CET1) ratio stood at 11.0% (above the regulatory requirement) along with a liquidity coverage ratio of 135%. Internal capital generation was strong and contributed 20 basis points to the CET1 ratio, which was offset by 80 basis points reduction due to the increase in risk-weighted assets on account of higher lending. Further, Moody’s, S&P and DBRS assigned Aa3, A, and Aa credit rating to the banks, respectively with a stable outlook.

• An Income Play amid lower interest rate regime: The bank had a consistent track record of dividend payment, since the year 2000 to Q2FY20, the bank had increased its dividend with a CAGR of 10% to LTM CAD 3.01/share from CAD 0.46/share in 2000. At the current traded price, the bank is offering a lucrative dividend yield of 5.06%, which is relatively higher given the lower interest rate environment. Further, the dividend yield of 5.06% is approximately 8.8 times of the Canada 10 Year Benchmark Bond Yield is at 0.57%. The bank has a target pay-out range of 40-50%.

Source: Company Reports

• Loan book improved on a sequential and YoY basis: During the second quarter of FY20, the bank’s total loan book expanded by 9% on a YoY basis and 4% on a sequential basis. The strong loan growth was driven by a 36% annual increase in wholesale loan book, while U.S retail loan book grew by 7% and Canadian retail loan book increased by 5%.

• Solid funding base: Almost 72% of the bank's total funding is made up of personal and business deposits which indicates a stable base. Despite a COVID-19 challenged emerged across the globe, and economic activities are slowing across the board, TD has reported a decent deposit growth. On a YoY basis, the bank's deposits increased by 15% to CAD 787 billion. Deposits in Canadian retail segment surged by 10% on YoY basis to CAD 365.1 billion, while U.S retail segment deposits leapt up by 15% to USD 305.9 billion. 

Recent Development

On May 28, 2020, the bank announced a dividend of 79 cents/share for the quarter ending July 31, 2020, Further, the company stated that in lieu of receiving the dividend in cash, shareholders could choose to have their dividends reinvested in additional common shares of the Bank in accordance with the Dividend Reinvestment Plan. Under the Plan, the Bank has the discretion to either purchase the additional common shares in the open market or issue them from the treasury.  If issued from treasury, the Bank may decide to apply a discount of up to 5% to the Average Market Price of the additional shares. 

Financial Highlights: Q2FY20

During the quarter under consideration, the group's revenue improved by 3% to CAD 10,528 million against CAD 10,228 million reported in a year-over period. However, on account of a significant increase in the provisioning for credit losses (PCL), net income of the bank declined to CAD 1,515 million from CAD 3,172 million reported in the same quarter of the previous financial year. Provisioning expense increased to CAD 3,218 million from CAD 633 million reported a year-before. However, a higher provision does not mean that the risk-weighted assets have significantly soared up, rather it's safety net against any future uncertainties. Out of total provisioning, approximately CAD 2,251 million accounted for provision against the performing assets, where chances of defaults are significantly lower.  Non-interest expenses on a YoY basis reduced by 2.4% to CAD 5,121 million as compared to CAD 5,248 million reported in the year-over period.  Consequently, the efficiency ratio improved to 48.6% from 51.3% in pcp. Further, during the quarter under review, the bank's CET1 ratio stood firm at 11%, which is above the regulatory requirement, though declined from 11.7% at the end of Q1FY20.

Source: Company Presentation

Segment Performance – Q2FY20

Canadian Retail: During the quarter under review, reported net income stood at CAD1,172 million, slumped 37% on a YoY basis, primarily on account of higher provisioning and non-interest expenses, though partially offset by the revenue growth. The total provision in the Canadian retail segment stood at CAD 1,153 million, reflecting higher provisions in the commercial and consumer lending portfolios. The group set aside CAD 788 million out of the total PCL against performing assets, primarily reflecting a significant deterioration in the economic outlook.

U.S. Retail: Net Income in the U.S. retail Segment declined to USD 261 million, reflecting higher PCL, lower revenue, reduced trading commissions and higher operating expenses, which was partially offset by increased trading volumes. During the quarter, provisioning against the impaired loans remained flat, while provisioning for performing assets stood at USD 606 million mainly because of significant deterioration in the economic outlook.

Wholesale Banking: Revenue increased ~42% to CAD 1,261 million from CAD 374 million in pcp, reflecting higher trading-related revenue from interest rate and foreign exchange trading and higher debt underwriting fees, which was partially offset by losses in equity trading amid volatile markets. However, net income declined by 5% on a YoY basis, reflecting higher PCL.

Key Risk:

A lot of businesses faced a temporary shutdown owing to the COVID-19 Pandemic, which is likely to result in a higher unemployment rate. Further, these businesses might take time to resume operations and generate profitability. Consequently, the bank might face a delay in receiving the repayment of loans, and the demand for new loans might be affected, which could dampen the bank’s performance. Further, a volatile equity market and sluggish economic activities may also affect the bank’s businesses.

 

Stock Performance

At the time of writing (on June 15, 2020) TD’s stock is trading at 61.28, down 1.8% from the previous close. In a year-over period, its shares have registered a 52W high of CAD 77.96 (as on July 05, 2019) and a 52W Low of CAD 49.01 (as on March 23, 2020).

1-year price return (as on June 15, 2020, before the market close). Source: Thomson Reuters.

Further, the short-term trend is favourable as the stock has bagged approximately 10% return in a month period, 20.4% in the past 3-months. At the last traded price, its shares were trading above the crucial short-term support level of 30-day, 50-day, and 60-day simple moving average, which indicates a positive trend in the stock. Further, the stock is heading towards its long-term support of 200-day SMA of CAD 68.73, another positive trend. 

Outlook

The US Federal Reserve responded to the global pandemic by cutting the Fed funds rate near zero and introduced quantitative easing measures. In the latest Federal Reserve meeting, the bank holds its benchmark funds rate unchanged in a range of 0-0.25%. We expect the Fed to hold rates at the current level in the near to medium term to support the economic recovery. Further, The Bank of Canada followed its US counterpart and reduced the overnight rate to 0.25% and introduced various asset purchase programs to support financial conditions. Given the lasting impact of the pandemic, we expect the Bank of Canada to maintain a status quo on its policy rate (similar to Fed) until economic growth shows some sign of recovery. A lower interest rate regime is likely to weigh on the banks’ net interest margin, but it would help in increasing the credit offtake in the economy, which would drive the banks' loan book and offset the impact of lower interest margin on the banks’ earnings.

 

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 21.88% of the total shareholding. RBC Global Asset Management Inc. and The Vanguard Group, Inc. holds the maximum interests in the company at 3.15% and 3.14%, respectively.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): Price to Book Value Based Valuation

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters).

 

Stock Recommendation

Toronto-Dominion Bank has reported modest result for the second quarter of FY20, wherein revenue grew 3% while expense declined. Higher provisioning weighs on the group's net income, though most of the provisioning was against the performing assets, mainly because of a significant deterioration in the economic outlook. We believe, the higher provisioning is likely to provide a cushion against the near-term hiccups arising from defaults, if any. Further, the group recorded decent growth in its loan book along with robust growth in deposits. Deposits are forming a majority of the bank's funding sources, which is positive. Also, the expectation of persisting lower interest rate environment is likely to help the bank in expanding the loan book. At the same time, it would build short term pressure on the net interest margin.

From an income investor's standpoint, the bank is offering a lucrative dividend yield of 5.06%, which is relatively higher given the lower interest rate regime, and the bank has proven track record of consistent dividend payment and dividend growth over the last two decades. Further, despite higher provisioning and amid challenging business environment where most of the businesses are cancelling dividend payment, TD has announced a dividend of CAD 0.79/share as on May 28, 2020. This reflects the balance sheet strength of the bank. 

Also, from the technical analysis standpoint, the bank's shares are trading above the crucial short-term support levels of 20-day, 30-day, 50-day and 60-day simple moving averages and also heading towards its 200-day SMA price of CAD 68.7, a positive price trend.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a "Buy" recommendation at the current price of CAD 61.28 (as on June 15, 2020), with lower double-digit upside potential, based on the Peer’s Average Price-to-Book Value Per Share multiple of 1.4x, on the FY20E Book Value per share of CAD 50.33. We have considered, Canadian Imperial Bank of Commerce (TSX: CM), Royal Bank of Canada (TSX: RY) and National Bank of Canada (TSX: NA) etc., as a peer group.

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