TD Bank: A High-Yielding Dividend Stock Worth Buying Now (NYSE:TD)

Stating that humans are emotional beings is a fact of life. Throughout life, just about everybody experiences all the basic emotions at some point. These include happiness/euphoria, sadness, fear/anxiety, disgust, anger, and surprise.

Whether it’s on the job, in relationships, or involving strangers, human emotions and psychology have important applications throughout every aspect of life.

That’s why I would argue that gauging what people are feeling, how they are feeling it, and when they are feeling it, is a key part of achieving our goals.

Taking the finances out of it for a moment, investing is the ultimate game of human psychology. Throughout the market, this is clear in a couple of different ways.

Momentum investing tends to play on the human emotions of greed and fear of missing out or FOMO. Even if the underlying quality of an investment is superb, the last in line with this approach is still oftentimes left holding the bag.

That’s because valuation matters significantly. No matter how great a business may be, if a bunch of growth is already priced in, not even amazing execution is usually enough to avoid years of dead money.

On the other hand, the form of investing that I will be discussing with my pick today is value investing. This investing strategy plays on the human emotions of fear/anxiety.

Whether it is justified or not (it usually isn’t in my view), the noise of a particular company-specific or macro event sets off a panic among some investors. In times of market/sector/stock volatility, those with “weaker stomachs” tend to head for the exits.

For me, I usually view these types of events as buying opportunities. This is because the flurry of emotions within the markets leads me to believe that not all equities are appropriately priced at all times. Thus, I’m an opponent of efficient market theory.

If I wasn’t, I wouldn’t be here on Seeking Alpha. After all, that’s the basis for the formation of this site.

This brings to mind The Toronto-Dominion Bank (NYSE:TD). When I initiated coverage with a buy rating in March, there were a few elements behind this rating.

I liked the company’s extensive presence in two of the world’s strongest economies: Canada and the United States. I also appreciated the company for its 167-year track record of not missing a dividend payment. I found the financial giant’s prime credit ratings from the major rating agencies to be another positive. Finally, the valuation looked to be a deal.

Well, deals can become even better bargains in a fickle market. As the S&P 500 index (SP500) has gained 2% during that time, TD has shed 7%. Intensifying concerns regarding money laundering cases are likely responsible for this dip.

But as I’ll discuss, I believe this selloff is overdone. On May 23, TD shared fiscal second-quarter results that point to respectable operating strength.

Management is taking the money laundering cases seriously and improving internal controls. As this is demonstrated to rating agencies, credit rating outlooks should improve.

In the meantime, I believe the share price drop means the valuation remains appealing, even with the temporary regulatory headwinds. So, I’m reiterating my buy rating today.

Excellent Q2 Results And Concerns Are (Probably) Overblown

TD’s operating results for the fiscal second quarter painted the picture of a business that is doing well in the face of challenges. The company’s revenue surged 9.9% higher year-over-year to $10.1 billion during the quarter (all figures to follow are also in USD). This was almost $1.1 billion ahead of Seeking Alpha’s analyst consensus in the quarter.

TD’s Canadian Personal & Commercial Banking business benefited from higher loan volumes and deposit volumes for the fiscal second quarter. This is what pushed revenue up by a high-single-digit rate (including CAD/USD) foreign currency translation headwinds during the quarter. All the while, the net income margin was flat sequentially at just over 2.8%. Net income also moved higher at a mid-single-digit rate in the quarter.

TD’s U.S. Retail segment revenue was down 3% for the fiscal second quarter. This was because lower deposit volumes (-6% or -1% excl. sweeps) couldn’t be fully countered by greater loan volumes and fee income growth from increased customer activity. Significant expense growth (+28%) linked to anti-money laundering investigations provision and charges for the terminated First Horizon transaction weighed on net income during the quarter. This is why net income was down by double-digits in the quarter.

The company’s Wealth Management & Insurance segment revenue climbed higher by nearly double-digits for the fiscal second quarter. Insurance premium hikes and increased fee income in wealth contributed to this growth during the quarter. Expenses were up less than revenue growth, so net income surged by double-digits in the quarter.

Finally, Wholesale Banking revenue was up by double-digits for the fiscal second quarter. That was due to the inclusion of TD Cowen in results, as well as an uptick in trading-related revenue and underwriting fees during the quarter. This is how net income more than doubled in the quarter.

Thanks to these operating results, TD’s non-GAAP EPS grew by 4.9% over the year-ago period to $1.49 for the fiscal second quarter. That was $0.14 better than Seeking Alpha’s analyst consensus.

Looking forward, TD’s medium-term outlook remains on track and promising.

One of my biggest takeaways from the company’s Q2 2024 Earnings Call was that it is executing well throughout its business.

Per CEO Bharat Masrani’s opening remarks during the earnings call, TD is a year into its medium-term targets for its Canadian retail businesses. One of the major goals that it set at the Investor Day last year was for the Canadian personal banking business to outgrow Canada’s population. The most recent data shows that net customer growth thus far exceeded Canadian population growth by 30 basis points.

This is being accomplished by investments that have been made to offer Canada’s most engaging digital banking app. That is paying off via the highest number of average smartphone monthly active users in the country.

Additionally, TD is delivering on its objective in the insurance business to become Canada’s fastest-growing personal lines insurer. In the past year, the company has gained market share in personal lines across every province.

The company’s innovation to engage customers also appears to be materializing in the U.S. In Q2, TD surpassed 5 million active mobile customers in the country.

The company is also responding to the preferences of wealth management customers. During the quarter, TD added seven fixed-income ETFs to its product suite.

As all of these encouraging developments bear more fruit, that should be reflected in the company’s growth outlook. That is why after an anticipated 0.6% decline in non-GAAP EPS to $5.86 in FY 2024 per FAST Graphs, analysts rightfully believe that TD can return to growth. It’s also important to point out that factoring out unfavorable foreign currency translation, the company’s non-GAAP EPS would marginally grow this year.

For FY 2025, another 4.5% in non-GAAP EPS growth to $6.12 is currently being predicted. In FY 2026, an additional 10.8% growth in non-GAAP EPS to $6.78 is being expected.

The fallout from the alleged AML scandals hasn’t been without potential consequences for TD’s credit ratings.

Since my last article, S&P and Fitch have downgraded their outlooks on TD from Stable to Negative. The revised outlook from the former carries a one in three risk that a downgrade in the A credit rating could happen in the next two years.

Aside from probability, I’m betting more on the two out of three scenarios that TD’s A-rated credit ratings are here to stay.

The company has already fired more than a dozen people for their conduct associated with the alleged failures in AML controls.

According to Masrani, the company has already invested 500 million CAD ($365 million) in AML remediation efforts. Not only will this overhaul the U.S. AML program, but it will improve the program globally.

In the quarters to come, TD will likely continue to set money aside for remediation efforts and potential regulatory fines. Potential outcomes discussed by fellow analyst A.J. Button range from a $450 million fine to a Bank of America-esque (BAC) fine of $30 billion. Per Button, Canadian banking expert Gabriel Dechaine anticipates around $2 billion, so low billions seem to be the smart money outcome.

Reframing TD’s selloff in another way, TD’s market capitalization dropped by almost $8 billion to below $100 billion since my prior article. Since I believe that the costs to the company will be in the low billions, I think this selloff was a bit excessive (unless otherwise sourced or hyperlinked, all details in this subhead were according to TD’s Q2 2024 Investor Presentation).

TD Could Be Worth Nearly $65 A Share

Even by conservative valuation metrics, TD looks to be an interesting value from the current $56 share price (as of June 6, 2024).

The company’s current-year P/E ratio of 9.6 is well below the 10-year normal P/E ratio of 11.8 per FAST Graphs. This is arguably an irrationally low valuation.

That’s because TD has historically grown non-GAAP EPS by 5.1% annually in the past 10 years. The forward three-year consensus of 6.2% shows that the company’s growth prospects remain intact.

Accounting for the AML overhang, I believe the case can be made that a reversion to the 10-year normal P/E ratio won’t happen for the foreseeable future.

Regardless, the durable growth prospects justify a valuation re-rating one standard deviation higher than the current multiple. This is why I think a multiple of 10.6 is a sensible fair value estimate moving forward.

TD’s results for FY 2024 are 50% complete. Adjusting for the 50% remaining and the 50% of FY 2025 that is to come in the next 12 months, I get a non-GAAP EPS input of $5.99.

Plugging that in with a 10.6 valuation multiple, I get a fair value of just above $63 a share. That would equate to an 11% discount to fair value. If TD grows as projected and returns to fair value, it could post 43% cumulative total returns by the end of October 2026.

More Dividend Growth Should Lie Ahead

In just about any market environment, TD’s 5.4% forward dividend yield is enticing. When considering the 167-year continuous dividend payment history (slide 28 of 86 of TD’s Q2 2024 Investor Presentation), this is especially true.

In the years ahead, I anticipate TD will hand out at least mid-single-digit annual dividend raises. This is because the FAST Graphs consensus is for $2.98 in dividends per share to be paid in FY 2024. Against the consensus for $5.86 in non-GAAP EPS, that would be a 50.9% payout ratio.

This is essentially within the company’s targeted range of 40% to 50%. So, that guides my belief that dividend growth will be about in line with earnings growth for the foreseeable future. In my opinion, a 5.4% yield and mid-single-digit annual dividend growth is an intriguing combination of immediate income and future income.

Risks To Consider

AML headwinds aside, TD is a business that is executing well. However, some risks could derail the investment thesis.

If AML remediation efforts and penalties reach tens of billions of dollars, that could weigh on the business for longer than I currently expect. This could lead to underperformance from the stock for at least the next few years.

Just as I highlighted in my previous article, TD is a frequent target of attempted cyber breaches. If any of these were successful on a large scale, sensitive information could be in jeopardy. That could lead to litigation and a loss of customer trust. In a worst-case scenario, this could be enough to break the investment thesis.

Summary: A Pick For Income And Value

From my vantage point, there’s still a lot to like about TD if it can overcome the AML obstacles. The company’s growth outlook is solid. The balance sheet is still A-rated. TD’s dividend is very steady and should keep growing. Lastly, shares could be moderately undervalued. That’s why I’m maintaining my buy rating.