Toronto-Dominion Bank (TSX:TD) has been one of Canada’s most beaten-down equities over the last year. Thanks to a years-long money-laundering investigation into the company by the U.S. Department of Justice (DoJ), the company’s stock has fallen hard. It was falling all through the investigation, recovered, and then took another dip when the DoJ concluded the investigation & assessed a $3 billion fine and a $430 billion asset cap.
As a result of having fallen so hard, TD is now one of the cheapest Canadian big bank stocks going by adjusted earnings. The adjusted price-to-earnings (P/E) ratio — using an earnings metric that excludes the fine impact — is a mere 9.5. Years ago, such multiples were quite common for large North American banks, but a major rally in bank stocks made them rare. TD is one of the few large banks that can still be had so cheaply.
The question is, “Where will TD Bank stock be in five years?” It’s all well and good to say that TD Bank is cheap compared to last year’s earnings, but last year is not the future. If investors can’t keep earning the same amount of earnings per share (EPS) in the future as in the past, then eventually, TD’s dividend might have to be cut. In this article, I will explore the implications of TD’s money-laundering settlement so investors can gauge whether the stock is a good buy today.
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Implications of the anti-money-laundering settlement
TD Bank’s money-laundering settlement came in two parts, one of them is fairly minor; the other is potentially a big deal:
- A $3 billion fine
- A $430 billion cap on its U.S. operations
The $3 billion fine in itself is no big deal. TD usually does about $10 billion in profit per year. To put that in perspective, the fine is about 3% of TD’s next 10 years’ earnings if everything else goes reasonably well for the company.
The asset cap is potentially a bigger deal. $430 billion is about the size of TD’s U.S. retail business right now, which means basically, U.S. regulators are saying that TD can’t grow its U.S. business. The business can still be profitable going forward, but the money will have to go to dividends or buybacks or else be transferred to other parts of TD’s business. TD literally isn’t allowed to open new U.S. branches, buy out U.S. banks, or do basically anything else that would grow TD U.S. retail.
The good news is that TD has plenty of places to invest money that it gains from U.S. retail.
It could buy a U.S. investment bank (TD’s U.S. investment banking segment is exempt from the asset cap).
It could transfer money to the Canadian business and, due to improved capital ratios, empower itself to lend more money out in Canada.
Finally, it could do those big dividends and buybacks alluded to earlier. There are many ways TD could put money from U.S. retail to work in other parts of its business.
Profitability and growth
Another set of factors arguing that TD’s future is better than its recent past is the company’s profitability and growth metrics. TD has about a 23% profit margin, and it grew its revenue 10% last quarter. The fine took a big bite out of earnings, but the long-term potential here is solid.
Verdict: TD will be in a better place in five years
Taking everything into account, it looks like TD Bank will be in a better place in five years than it is today. The company still has plenty of investment opportunities and is now staffed to the brim with money laundering experts who will keep it out of trouble. On the whole, I’m comfortable owning TD Bank stock today.
