Inside Wall Street: Toronto-Dominion Is a Banking Play Worth Knowing About

Gene Marcial's Inside Wall Street
Gene Marcial's Inside Wall Street

Looking for a formidable foreign bank with a solid North American exposure that Wall Street and U.S. investors continue to largely ignore? Try Toronto-Dominion Bank (TD), Canada's second-largest bank. Its traditional way of doing banking has left it untainted by the scandal over subprime mortgage lending, collateralized debt obligations, murky derivatives trading and the like. So, its stock hasn't suffered the jolting shocks like the major U.S. banks have experienced.

Shares of TD, which closed on July 8 at US$67.87, up from a 52-week low of $47.90 on July 9, 2009, are definitely more attractive than most of America's giant banks, says John Maloney, president of M&R Capital Management, who puts TD's value at $85 a share. "It is a very solid bank with a clean balance sheet, with no credit derivatives to lose money on, very negligible proprietary trading -- and no exposure to the mess in Europe," says Maloney. And equally important, its stock remains cheap with a dividend yield of 3.5% as a kicker, he adds.

Maloney notes that TD resembles the old U.S. bank industry, operating in a very protected domestic market with limited foreign competition. Some 80% TD's business is retail, it follows strict underwriting standards and it retains and services most of the mortgage loans it issues. The Canadian housing market, notes Maloney, fell only 4% from peak to trough, vs. the 19% drop in the U.S. Real estate in the U.S. accounts for only 5% of TD's total loans. Some 16% of its operations are in the U.S., including its TD Ameritrade (AMTD) unit, which accounts for 3% of TD's earnings.

Maloney figures TD's revenues will grow 10% and earnings 16% on average annually through 2012. TD's stock valuation is "compelling," he says, at just 10.1 times analysts' fiscal 2011 earnings projections.

Cross-Promotional Opportunities

Among the other TD bulls on Wall Street is Morgan Stanley, which rates the stock overweight. "TD is our top pick in Canadian banks," says Morgan Stanley analyst Cheryl M. Pate. With the credit recovery under way in Canada, "we see the most upside to TD," she notes. A significant relationship opportunity exists between TD Bank and AMTD, says Pate, who puts their combined customer base at 10 million. She says TD can offer banking access to 5.4 million AMTD customers, and AMTD could provide brokerage services to TD bank customers. TD forecasts that AMTD deposits will grow from $41 billion to $49 billion in three years.

Pate projects TD will earn C$6.13 a share in 2010 (one U.S. dollar equals 1.0445 Canadian), C$7.37 in 2011, and C$8.85 in 2012. Her 12-month price target is US$72.95.

In the U.S., TD is expected to steer clear of the troubles befalling its American counterparts. "TD's operations will perform reasonably well through a very challenging operating environment," says Steve Theriault, Canadian-based analyst at Bank of American Merrill Lynch, who rates the stock a buy.

Despite the financial crisis in the U.S., he expects TD will emerge with "a very solid North American banking franchise," with its very strong capital ratios and below-average payout ratio. TD's domestic retail banking operations are the "crown jewel that underpins its solid franchise, says the analyst, who notes that the bank has little exposure to the capital markets businesses.

Theriault believes TD's below-average valuation and superior near-term earnings outlook make it "a compelling stock."

Not Burdened Like U.S. Banks

Having just been through the financial crisis and now facing new regulations under the financial reform bill, investors -- particularly the individual investors -- have been naturally wary of banking stocks. What's comforting about TD Bank is that it's not burdened by the heavy financial and political baggage that the big U.S. banks have.

In fact, several major banks are among TD's top shareholders, including Royal Bank of Canada, which owns a 4% stake; Bank of Nova Scotia with 2.8%; and Harris Financial, with 4.6%. TD could very well be attractive, too, for individual investors.