Welcome to part three of The Great Canadian Banking Series. In this 10 part series I examine the Canadian banking sector to identify good dividend growth candidates. In part two of the series I looked into Bank of Nova Scotia. Today I’ll be looking into Toronto-Dominion Bank.
Before I start the dividend stock analysis I want to mention to new readers that there is another article that you may want to read first. The other article better explains what I’m looking for in a company from a dividend growth perspective and why I analyze specific company components and ratios. The other article is meant more as an educational tool so that readers can better understand my dividend stock analyses. This dividend stock analysis will look at the company to identify if it is a good dividend growth candidate to invest in.
From Google Finance:
“The Toronto-Dominion Bank is a bank. The Toronto-Dominion Bank and its subsidiaries are collectively known as TD Bank Group (the Bank or TD). The Bank serves approximately 20.5 million customers in four businesses operating in a number of locations in financial centres worldwide: Canadian Personal and Commercial Banking, including TD Canada Trust, TD Insurance, and TD Auto Finance Canada; Wealth Management, including TD Waterhouse and an investment in TD Ameritrade; U.S. Personal and Commercial Banking, including TD Bank, and TD Auto Finance U.S.; and Wholesale Banking, including TD Securities. On April 1, 2011, the Bank acquired 100% Chrysler Financial. On December 1, 2011, the Company announced that it completed the acquisition of substantially all of MBNA Canada’s credit card portfolio, as well as certain other assets and liabilities, from Bank of America Corporation. Effective March 27, 2013, The Toronto-Dominion Bank acquired Epoch Holding Corp.”
10 Year Stock Chart
There is a 10 year annual average return of 8.6%. If we include the dividend payments over the past 10 fiscal years (Total dividends paid of $20.73) then the total average annual return would be 11.0% with the average return from dividends representing 2.4%.
Out of the big six Canadian banks Toronto-Dominion has the best 10 year capital gain.
Revenue and Earnings
Toronto-Dominion Bank has a good overall revenue trend, and an OK net income trend. Net income overall has been increasing, but it has been a bumpy ride.
Revenue per share and EPS are all over the place. I was expecting to see a drop in EPS and revenue per share in 2008 or 2009 from the global financial crisis, but it looks like the negative trend started prior to the crisis.
Toronto-Dominion Bank has OK revenue charts, but I’d like to see an improvement in the consistency of earnings.
In fiscal 2002 Toronto-Dominion Bank had losses, so I calculated 11 year average annual growth rates. Net income and EPS growth rates are good, but the revenue figures are low. I typically like to see rates above 8%.
Toronto-Dominion Bank has increased their dividend for 2 consecutive years in a row, which doesn’t sound very impressive, but prior to this they had a 16 year dividend streak from 1994 to 2009.
The most recent increase occurred with the dividend recorded in April 2013 when they increased the quarterly dividend by 5.2% from $0.77 to $0.81. This was their second increase in the past year. Prior to the 5.2% increase they raised the quarterly dividend from $0.72 to $0.77. This would make the most recent annual increase from $0.72 to $0.81 which is a 12.5% increase.
In the chart you can see where dividend growth slowed around 2008-2010. The overall trend is good, and it looks like dividend growth has started to improve since the global financial crisis.
As you can see from the table below Toronto-Dominion Bank shows good 1 and 10 year average annual dividend growth rates, but leaves me wanting more with the other rates.
You can see the affects of the global financial crisis on the 3 and 5 year average annual dividend growth rates. The 10 year rate is good, and it looks like dividend growth has improved recently with the 1 year rate above 10%.
The 11 year average annual dividend growth has been slightly below earnings growth which points to sustainable dividend growth.
Let’s take a look at the payout ratio to see how much room for further dividend growth there is.
In the past few years the payout ratio has been around 40-50%, which is what I think Toronto-Dominion Bank will target in the future. Other banks like CIBC and Bank of Montreal have stated that they are targeting a payout ratio of 40-50%, and looking at Toronto-Dominion Bank’s payout ratio it looks like they are targeting a similar payout ratio. They also stated in a recent quarterly presentation that they are targeting 40-50% in the medium term.
Estimated Future Dividend Growth
Analysts expect annual EPS growth to be 7.8% for the next 5 years. Accepting this EPS growth rate and using various payout ratios we can guess future dividend growth rates.
I expect a payout ratio of 40% to 50%. This would result in annual dividend growth ranging from 6.4% to 11.2%. The company’s most recent annual dividend increase of 12.5% leads me to think that future dividend growth will be at the higher end of this range, likely around 10%.
Competitive Advantage & Return on Equity (ROE)
ROE is has been up and down. Typically I like to see a steady or growing ROE.
Looking at the table below, it looks like TD’s ROE has been below the industry average.
The Canadian banking industry is dominated by the big six banks. The big six are all very competitive so while there are not a lot of big players in the Canadian market, it is still very competitive. Morningstar rates Toronto-Dominion Bank as having a narrow economic moat. I would agree with this rating.
Debt & Liquidity
I want to invest in companies that are fiscally responsible, so it is important to look at debt levels and see that they are at reasonable levels.
Based on what the different rating agencies say, the company seems to be in good financial health.
Shares outstanding have been slowly increasing over the years. I’d like to see this trend reverse.
I use the low price averages for 6 main ratios to determine a fair price: Yield, Discount/Premium of the low price compared to the Graham Price, P/E, P/B, P/Sales and P/Cash flow. I like to look at both EPS and EPS from continuing operations so it ends up being a total of 8 ratios as the Graham Price an P/E both use EPS. I was unable to get all the P/Cash flow information I needed, so it wasn’t used. You can read more about my valuation method here.
I get the following for Toronto-Dominion Bank.
* The discount or premium to Graham Price hasn’t been calculated in the normal fashion. For the details read this article.
I use the averages from the previous table to determine my target price. Using these averages creates a lot of different target prices, so I back-test this strategy over the past 10 years. I identify which of the 8 valuation techniques would have given me a chance to buy the stock in two to three fiscal years in the past 10 fiscal years. It’s not always possible to test my strategy back 10 years, due to limited financial information, but I do my best. The results are highlighted below.
The average of the highlighted amount gives me a target price of $71. This would result in a dividend yield of 4.6% with the current annual dividend of $3.24. I think this a reasonable target, so I left the realistic target at $71.
Morningstar currently rates Toronto-Dominion Bank as a 3 star stock as it is currently priced close to their estimated fair value of $93. For Morningstar to rate Toronto-Dominion Bank as a 5 star undervalued stock the price would have to fall below their “consider buy price” of $55.80.
My target price of $71 is 27% higher than Morningstar’s 5 star target. This is quite difference, so I was worried that my target price wasn’t conservative enough. Whenever I need a tie breaker for valuation I like to use dividend yield. The 5 star price would result in a dividend yield of 5.8%, and my target price a yield of 4.6%. When I look at the past 10 fiscal years it looks like a yield of 4.6% is still conservative compared to past dividend yields.
Morningstar’s 5 star price is very conservative, and it looks like the only opportunity to buy at a 5.8% yield would’ve been in 2009 in the height of the global financial crisis. Having looked at historic high dividend yields, I’m content to keep my target price at $71. You can see all of my target prices here.
I also like to look at INO`s Free Trend Analysis prior to investing to see if I should hold off or not. Sometimes it is nice to see if the stock is trending down or up before buying it. For July 10, 2013 INO is showing a strong uptrend for Toronto-Dominion Bank.
Other Investment Options in the Same Industry
Toronto-Dominion Bank is one of six banks that make up the majority of the Canadian market. They share the industry with: Bank of Nova Scotia, Royal Bank of Canada, CIBC, Bank of Montreal, and National Bank.
All the banks offer a good entry dividend yield with rates ranging between Toronto-Dominion Bank’s 3.84% to CIBC’s 5.14%. With the exception of CIBC and Bank of Montreal, the banks show a similar trend in their dividend growth rates. The 10 year rates are good, but due to the global financial crisis the 3 and 5 year rates are low, and the 1 year rate shows an improvement. CIBC and Bank of Montreal haven’t shown the recent improvement in dividend growth rates that the others have. The dividend growth rates shown in the table are based on the dividends recorded in each calendar year from 2003 to 2012.
They all offer reasonable payout ratios with rates ranging from National Bank’s 40.00% to Bank of Montreal’s 49.50%. Looking at the various payout ratio history’s of all the banks and reading their annual reports it looks like the standard payout ratio target for the big six banks is 40-50% with the exception being National Bank. Based on past payout ratios National Bank looks like it is targeting a payout ratio of 30-40%. Using these payout ratio targets, the current EPS and the analyst’s 5 year annual EPS growth estimates I calculated an annual dividend growth estimate for each of the banks.
Royal Bank of Canada has increased its dividend twice in the past year which has led to an annual dividend increase of 10.5%. It looks like dividend growth has been improving and will likely be at the higher end of my estimated range of 4.9-9.7%.
CIBC recently increased their quarterly dividend from $0.90 to $0.94 with the dividend recorded in September 2012 and then again from $0.94 to $0.96 with the dividend recorded in June 2013. The annual increase from $0.90 to $0.96 is 6.7%. This would suggest that dividend growth will be at the higher end of my estimate of 3.0-7.7%, but still below the 8% I typically like to see. CIBC has stated that their target payout ratio is 40-50% so I feel like my estimate should be fairly close.
In the past year National Bank increased its quarterly dividend from $0.79 to $0.83 and then again to $0.87. This is a 10.1% annual increase. I expect annual dividend growth at the higher end of my estimated range of 5.6-11.9%. National Bank has the lowest payout ratio of all the banks which also suggests that it has the best ability to grow its dividend. That said National Bank typically likes to keep its payout ratio lower than the other 5 banks. There are a number of good dividend growth candidates among the Canadian banks, but overall I like National Bank’s dividend growth prospects the best.
Bank of Montreal’s target payout ratio of 40-50% is shown on their website, so I feel fairly confident in my dividend growth estimate of 4.9-9.7%. In the past year Bank of Montreal increased their quarterly dividend from $0.70 to $0.72 and then again to $0.74. This is an annual increase of 5.7%. Prior to these two increases the dividend was held steady for a number of years with the previous increase recorded with the November 2007 dividend when it was increased from $0.68 to $0.70. Bank of Montreal was the slowest of the big six banks to recover from the financial crisis and begin dividend increases again. While the dividend increases appear to have started again, it is not at the 8% or above rate I like to see. With its most recent increases it looks like the dividend increases will be in the middle of my dividend growth estimates.
From a dividend growth perspective National Bank, Bank of Nova Scotia and TD Bank show the most promise. I think Royal Bank offers appealing fundamentals too, but prefer the previous three banks just mentioned. I think CIBC and Bank of Montreal will offer lower annual dividend growth below my target of 8% or more, so for the time being I don’t think I’d invest in CIBC or Bank of Montreal. Now that I’ve reviewed the dividend fundamentals lets take a look at valuation.
All the banks seem to be trading fairly close to their 5 year yield averages, which normally suggest a fair value. The 5 year period includes a time when bank stock prices were very low due to the global financial crisis, so the 5 year average yield could also indicate a slight undervaluation. If we look at the current price compared to Morningstar’s fair value it looks like most of the banks are undervalued by around 10%, with the exception of Royal Bank of Canada and Bank of Montreal. Bank of Montreal appears to be fair valued and Royal Bank of Canada looks a little overvalued.
Bank prices have come down a bit recently, but I’d need prices to drop another 10-20% before they fell below my target prices. I’d be interested in investing in Toronto-Dominion Bank, Royal Bank of Canada, Bank of Nova Scotia and National Bank should they fall below my target price. Bank of Montreal and CIBC don’t offer the dividend growth I’m looking for so I don’t plan on investing in these banks for the time being.
Right now Toronto-Dominion Bank is a little above my target price, but should it come down to $71 I’d consider investing. At $71 the dividend yield would be an enticing 4.6% and I expect future annual dividend growth around 10%. There are other banks that offer similarly enticing dividend fundamentals so it might just be a matter of waiting for the first one to fall below my target price. Should this happen I’d consider investing in National Bank, Bank of Nova Scotia, Toronto-Dominion Bank, or Royal Bank of Canada.
I own shares of Bank of Nova Scotia and Royal Bank of Canada. You can see my portfolio here. I also own a small amount of shares of Bank of Montreal, and Canadian Imperial Bank of Canada that were left over from my DRIP selling days. I am a blogger and not a financial expert. These writings are my own opinions and should not be considered financial advice. Always perform your own due diligence before purchasing a stock. I mention target prices in this article, but this is not a recommendation to buy this stock, it is just a target price I use for my own personal investing that I have chosen to share.