The Toronto-Dominion Bank (TD, Financial) has underperformed the S&P 500 year-to-date as the stock’s 15% return since the start of 2021 trails the 20.5% gain for the index.
However, the company reported very good earnings results nearly across the board at the end of August that provide some evidence that Toronto-Dominion’s business is already ahead of where it was prior to the pandemic. Shares trade below their long-term average valuation while paying a generous dividend yield of almost 4%. Let’s look deeper into the company and its most recent earnings report to see why I feel that Toronto-Dominion can offer double-digit returns from the current level.
Earnings highlights
Toronto-Dominion reported earnings results for its third quarter of fiscal 2021 on Aug. 26 (all figures are in U.S. dollars unless otherwise noted). Revenue grew 3.5% to $7.8 billion, beating Wall Street analysts’ estimates by $153 million. Adjusted earnings per share of $1.54 compared favorably to adjusted earnings per share of 95 cents in the prior quarter and was 5 cents higher than analysts had anticipated. Net income grew 53%.
The company took a recovery of credits losses (PCL) of $29 million for the quarter, down from the more significant decrease in PCLs that it recorded in the second quarter. Toronto-Dominion had previously taken out about $2 billion in PCLs in the third quarter of last year as it anticipated an influx of bad loans due to the pandemic. However, performing loans improved a staggering 85% from the prior year, so the company was able to reduce the PCL ratio 119 basis points to -0.02%. Average total loans improved 1.5% sequentially, but were down fractionally year-over-year.
Revenue for the Canadian Retail segment grew 9% from the prior period, mainly due to a nearly 90% decrease in PCLs. Average loan balances improved 7%, driven by an 8% increase in personal loans. Deposits grew 13%, with pronounced gains seen in commercial deposits. Net interest margin fell 7 basis points to 2.61%, but was flat quarter-over-quarter.
U.S. Retail had revenue growth of 5% during the quarter. Higher fees related to an increase in customer activity was the main driver of growth during the period. Deposits grew 10%, led by an 18% increase in personal deposits. Loans declined 5% year-over-year, but were down marginally on a sequential basis. PCL was a recovery of $74 million as the PCL ratio improved 169 basis points to -0.18%. Net interest margin declined 34 basis points to 2.16%. This was a 1 basis point increase from the second quarter of 2021.
Wholesale Banking fell 22% from the prior year, but just 6% sequentially. This decline was due to a 50% decrease in trading-related revenue that was partially offset by advisory fees and other revenue.
The company continues to leverage its digital ecosystem to attract customers. Digital adoption as a percentage of total customers improved 230 basis points to 61.3% in the Canadian Retail segment and expanded 310 basis points to 50.7% in U.S. Retail. Activate mobile users for the combined segments increased 10.6% to 10.4 million. Self-serve transactions did fall from the prior year, but stood at 92% and 78.9% of total transactions for the Canadian and U.S. Retail segments, respectively.
Toronto-Dominion’s common equity tier 1 ratio improved 200 basis points to 14.5%, demonstrating that the bank was in a very strong capital position at the end of the quarter.
Takeaways
Much of the improvement in the quarter was due to the recovery of credit losses compared to the prior year. PCLs stood at nearly $2 billion in the third quarter of 2020, but Toronto-Dominion is now in the recovery period, so it does not have to set aside as much money for bad loans. This can largely be attributed to the improvement in economic activity and employment levels in both Canada and the U.S., as well as to the company’s prudent lending operations.
The dramatic turnaround in PCLs demonstrates Toronto-Dominion’s ability to weather extreme impacts to its loan portfolio. Even in the worst of the pandemic, the PCL ratio was incredibly low. Less than 1% of average total loans were ever impaired or performing, a considerable achievement given last year’s environment.
Toronto-Dominion’s quarter wasn’t just ahead of last year’s pandemic-impacted results, but also improved compared to the year prior to Covid-19. Revenue was up almost 6% from the third quarter of 2019, while adjusted earnings per share improved 14.1%. Toronto-Dominion looks to be better positioned than it was before the pandemic.
Shares of Toronto-Dominion closed Monday’s trading session at $65. Using analysts’ expectations, the stock has a forward price-earnings ratio of 10.6. According to Value Line, shares have traded with five- and 10-year average price-earnings ratios of 12.1 and 12.2, respectively. The market has valued Toronto-Dominion with remarkable consistency over the medium- and long-term.
Appling a price-earnings ratio of 12 to expected earnings per share for the year results in a price target of $74. Achieving this target would mean a 13.8% return from the current price.
Added to this would be Toronto-Dominion’s dividend. Presently, shares yield 3.8%. Combined with multiple expansion, total returns for the stock could reach into the mid-double-digit range.
Final thoughts
Toronto-Dominion has really seen a turnaround in its business since the worst of the pandemic last year. PCLs are a far cry from where they were at this time last year. Even at its height, PCLs were a small fraction of the company’s total loan portfolio. To me, this speaks to the quality of Toronto-Dominion’s business.
The market continues to assign the stock a multiple that is a double-digit percentage below where the stock has historically traded. Given the quality of the company and potential total returns, this could be an excellent opportunity for investors to add Toronto-Dominion to their portfolio.
