Toronto-Dominion Bank has emerged from the second-quarter earnings season as the clear winner among the Big Six, and its shares are reflecting the strong results. Can TD maintain its lead?
To be sure, all six banks reported strong results.
Their combined profit during the quarter was $11.3-billion, up $1.1-billion or 11 per cent from the fiscal second quarter of 2017 – impressive growth given that these are financial behemoths whose lending activity is partly tethered to the slowing Canadian housing market and indebted consumers.
The banks’ adjusted earnings, which ignore some unusual expenses and payments to give a better impression of the banks’ financial operations, were even better: They increased 12 per cent, year over year.
On average, these adjusted earnings were 4 per cent higher than the consensus expectation among analysts and all six banks beat expectations.
So, the banks delivered – but their results were hardly even, giving investors something to think about if they prefer to hop from one stock to another, rather than stick with one bank through thick and thin.
Canadian Imperial Bank of Commerce actually delivered the strongest profit growth, at 26 per cent. But various adjustments – the bank hadn’t closed its acquisition of Chicago-based PrivateBancorp Inc. in the second quarter of last year – reduce the adjusted earnings growth to 12 per cent.
And some analysts, including RBC Dominion Securities’ Darko Mihelic, believe that further adjustments related to tax loss carry-forwards and other items could reduce CIBC’s year-over-year growth to just 8 per cent – decent, but not stellar.
Bank of Montreal was another outlier (in a bad way): Its net profit growth was zero. Add a restructuring cost of $260-million, owing to severance expenses and the like and its adjusted earnings increased 15 per cent over last year.
But if BMO is booking restructuring costs every year (its current record is four years in a row), is it fair to label these costs as one-time items in adjusted earnings? Analysts are starting to wonder.
Which brings us to TD. Net profit increased 17 per cent. And adjusted earnings growth was even better, at 21 per cent – the best adjusted growth among the Big Six. TD also beat analysts’ expectations by 8 per cent, the best “beat rate” among its peers.
The bank is firing on all cylinders: U.S. retail operations, which drive 29 per cent of TD’s annual profit, are being helped by rising U.S. interest rates; Canadian commercial lending is rising at a 10-per-cent clip; and the bank’s efficiency ratio, which compares expenses with net income, is declining (down is good).
Few observers expect this pace of growth to continue.
“Will growth slow from here? Yes, and it had better,” Robert Sedran, an analyst at CIBC World Markets, said in a note to clients. “We would worry about a bank posting 22-per-cent year-over-year growth in earnings per share for very long, since outsized risks tend to come with outsized growth for a prolonged period.”
Still, investors appear to be siding with TD. Among the Big Six, its shares are the only ones in positive territory this year: They are up 2.2 per cent, as the broader banking sector struggles amid concerns about the Canadian housing market and new lending regulations.
That’s more than six percentage points ahead of Royal Bank of Canada and 10 percentage points ahead of CIBC.
Nonetheless, Canadian bank stocks can be driven by factors beyond performance. Buying bank stocks with high dividend yields is a strategy that has a good track record. Even better, buying last year’s underperforming bank stock has worked wonders, since banks are good at rebounding. (Since 2000, the strategy of picking last year’s laggard has returned 17 per cent, on average, versus 11 per cent for the S&P/TSX commercial banks index and 5 per cent for the S&P/TSX Composite Index.)
BMO was last year’s dud, which makes it this year’s pick. The strategy is getting mixed reviews so far: Although BMO is down slightly this year, the shares are beating four of BMO’s peers and are ever-so-slightly ahead of the S&P/TSX composite index.
TD is in the lead. But BMO may be the stock to watch.