Dominion Bank (TD) (TSX: TD) is a well-managed company with the best efficiency ratio of one of Canada’s top five banks. It has an important presence in the United States. This will allow the bank to benefit from the current rising interest rate cycle. The company also has a very good record of dividend growth in the past. However, its stock price is slightly overvalued. Given the uncertainties of TD Bank’s Canadian mortgage lending business to the Canadian real estate market, I think it’s best to take a wait-and-see approach.
The TD Bank is one of the most efficient banks in Canada. Banks know how to control their expenses. In the past year, the bank has successfully achieved business growth while reducing its number and retail location by 1.1% and 1.6% respectively. As a result, its total expenditure fell by 1% from a year ago. In fact, spending in the previous quarter fell by 1% from a year ago.
One of the highest efficiency ratios in the industry
The TD Bank has the best efficiency ratio among Canadian banks. For those who may not be familiar with it, the efficiency ratio is a measure of the bank’s internal use of assets and liabilities. A lower efficiency ratio means that the bank is more efficient in using its assets and liabilities. In its fiscal year Q1 of fiscal year 2018, its efficiency ratio in the retail business sector in Canada was 41.6% (see table below). This ratio increased by 120 basis points from the first quarter of 2017. In fact, the efficiency ratio of TD Bank Canada’s retail sector is one of the highest among its peers. Its efficiency ratio in the first quarter of 2018 was 41.6%, which was only 41.5% higher than the Royal Bank of England (RY) and nearly 10 percentage points higher than the Canadian Imperial Bank of Commerce (CM) and Bank of Montreal (BMO).
Has an important position in the United States
The TD Bank has a great presence in the United States. It has the largest number of branches in the United States in Canada. In fact, about 32% of its net income came from the United States in the last quarter (about 28% from the US retail sector and 4% from TD Ameritrade). The TD Bank’s NIM in its US retail sector should be able to benefit from several rate hikes this year. In addition to the US retail sector, TD Bank also owns 42% of TD Ameritrade (Nasdaq:AMTD). In the first quarter of 2018, adjusted net income of TD Ameritrade increased by 65% year-on-year, which reflects the increase in asset income and increase in trading volume.
U.S. retail net interest margin (Source: Investor Presentation)
A good record of dividend growth
The TD Bank has a good record of dividend growth. Over the past two decades, the company’s dividends have grown at an annual rate of more than 10%. Its annual dividend has increased from 0.28 Canadian dollars per share in 1997 to 2.35 Canadian dollars per share in 2017. In fact, the company increased its quarterly dividend to 0.67 Canadian dollars (or 12%) at its latest earnings release. This is equivalent to an annual dividend of $2.68 per share (or a dividend yield of 3.5%).
But its stock price is quite important
The share price of TD Bank in the past year has risen by 17%. In the table below, we calculate the price-to-earnings ratio of TD Bank and its Canadian counterparts based on a consistent estimate of the returns in 2018 and 2019. As shown in the table below, TD Bank has set its ratio with RBC’s 2018 earnings per share to be 12.3 times, and is 11.5 times the average of its Canadian peers. Its 2018 earnings per share is also slightly higher than its 5-year average of 11.5 times. Similarly, TD Bank’s 2019 earnings per share was 11.9 times higher than its peers in Canada, averaging 10.9 times. The table shows that the stock price of TD Bank is slightly overvalued.
|Share Price (C$) on March 20||Consensus 18 EPS||Price to 18 EPS Ratio||Consensus 19 EPS||Price to 19 EPS Ratio||5-year Forward PE|
|Bank of Montreal||$99.31||$8.72||11.4||$9.26||10.7||11.1|
Source: Created by author; Yahoo Finance
The TD Bank is one of the most efficient banks in Canada. Its efficiency rate ranks among the top five banks in Canada. The TD Bank should be able to benefit from the rising interest rate cycle because it has an important presence in the United States. The company has also had an excellent record of dividend growth in the past and is expected to continue to grow in the future. However, TD Bank looks slightly overvalued. Therefore, I think TD Bank is currently in a state of hold, especially because of the uncertainty in the Canadian housing market.