Contrarian investors seek out quality stocks that have fallen out of favour with the market but have sound core businesses that should recover. Buying undervalued stocks takes courage and requires patience. Cheap stocks often get cheaper before the bounce. However, the strategy can also deliver attractive long-term gains.
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TD Bank
TD Bank (TSX:TD) trades near $80 per share at the time of writing compared to $108 in early 2022. The stock was as low as $74 in June but has picked up a bit of tailwind in the past two months as bargain hunters started to buy the stock.
TD’s operations in the United States are the core source of the pain over the last year. American regulators are investigating TD for not having adequate systems in place to identify and prevent money laundering. Media coverage on the issue has ramped up in recent months, and TD has booked more than US$3 billion in provisions for potential fines connected to the problem, with the first provision being US$450 million and the latest charge coming in at US$2.6 billion.
In the fiscal third-quarter (Q3) 2024 earnings statement, the company said it sold part of its stake in Charles Schwab to cover the recent provisions. Otherwise, the company would have depleted much of its excess cash position at a time when Canadian banks are maintaining healthy reserves to meet government requirements and to ensure they have the balance sheet strength to ride out a potential recession.
Analysts had predicted penalties as high as US$4 billion. There is also some concern that TD might be forced to scale back its growth ambitions in the American market.
TD continues to set aside more cash to cover potentially bad loans, and high interest rates put increasing pressure on businesses and households with too much debt. TD’s provisions for credit losses (PCL) in fiscal Q3 2024 came in at $1.07 billion. That’s up from $766 million in the same period last year.
Upside?
TD says it expects the final penalties south of the border to be close to the provisions it has already booked. This gives investors some clarity. There are still risks connected to potential growth restrictions, but TD will eventually get the issue sorted out in the American business.
When the latest provisions are stripped out of the Q3 earnings results, TD actually delivered a solid quarter despite all the headwinds and distractions. Adjusted net income for the three months came in at $3.65 billion, effectively in line with the same quarter last year.
Interest rates have already started to decline in Canada, and the U.S. Federal Reserve is expected to start cutting rates as early as next month. This will ease pressure on struggling borrowers and should lead to declining PCL in the coming quarters.
Investors who buy TD at the current level can get a 5% dividend yield, so you get paid well to wait for the rebound.
The bottom line
Ongoing volatility should be expected in the near term. Additional negative news south of the border or a jump in unemployment in Canada and the United States could potentially send TD stock back to the 12-month low. That being said, the stock already looks cheap and patient investors should do well holding TD over the long run.
