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The Science of Hitting
The Science of Hitting
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An Update on Wells Fargo

Some thoughts on the bank following 1st-quarter results

April 23, 2019 | About:

Wells Fargo (NYSE:WFC) recently reported financial results for the first quarter of fiscal 2019.

For the quarter, revenues declined slightly to $21.6 billion, with a 1% increase in net interest income from a higher net interest margin (NIM) offset by a 4% decline in noninterest income. Net income was $5.9 billion, with diluted EPS climbing to $1.2 (helped by a lower effective tax rate).

Total average deposits were $1.3 trillion, down 3% from the year-ago period. The decline was due to lower Wholesale Banking deposits (-8%) and Wealth & Investment Management deposits (-14%), partially offset by higher retail banking deposits (the decline in Wholesale Banking deposits reflects actions taken to ensure that the bank stays within the asset cap instituted by the Federal Reserve; the decline in WIM deposits reflects the reallocation of client cash to higher-yielding alternatives).

Community Banking deposits increased 2.4%, with the number of primary consumer checking accounts up 1% to 23.9 million. The number of checking customers has increased each of the past six quarters, with customer satisfaction and loyalty scores recently reaching three-year highs. It’s worth noting that the retail branch network has shrunk by 6% over the past year, with the number of teller and ATM transactions down 9% over the same period. Customer activity is migrating to digital channels, which is an advantage for the big banks relative to their smaller peers, as well as a potential source of material cost savings over the long run.

At quarter end, Wells Fargo’s Common Equity Tier 1 (CET1) ratio was 11.9%, well above the regulatory minimum (9%) and an internal target at Wells Fargo (10%, but with upside bias to 10.5% due to the implementation of CECL and the stress capital buffer). Even at higher internal target, that’s $18 billion in excess capital that should be returned to shareholders over the next few years. Capital returns are a key part of the story: Wells spent $3.9 billion on net repurchases last quarter, with the share count declining 7% year-over-year. In addition, the quarterly dividend was increased to 45 cents per share; the yield is nearly 4%, with ample coverage at current levels (the payout ratio is less than 40%). I expect Wells to repurchase about $45 billion of stock over the next three years -- equal to more than 20% of today’s market cap.

Conclusion

At quarter end, book value was $39.0 per share (up 5%), with tangible book value climbing to $32.7 per share (also up 5%). At the current stock price, Wells trades at less than 1.2x book and a single digit forward price-earnings multiple. When I look at the numbers, I see a path to roughly $6 of EPS a few years out. Put simply, I think this company is worth significantly more than $47 per share.

To be clear, there is still a lot of room for improvement at Wells Fargo -- but I think that is more than accounted for in today’s valuation. Between finding a new CEO, working with regulators to lift the asset cap (hopefully allowing them to return to “normal” growth rates), bringing the efficiency ratio in line with the company’s peer group, and working the CET1 ratio down to the company’s targeted range, there are some major unknowns here (in terms of timing and ability to execute). As it relates to the regulatory issues in particular, interim CEO Allen Parker’s commentary on the first quarter call was sobering (the words “regulators” and "regulation" were collectively said 27 times, compared to just twice on the fourth quarter conference call). What’s now clear is that former CEO Tim Sloan badly underestimated the company’s regulatory issues. It seems safe to assume that this could have implications for cost reductions and capital returns in the short run.

But even with that said, I remain confident that these issues will eventually be resolved. Their conclusion will provide significant opportunities for long-term value creation. As an investor, the right decision here is to be patient and accept that these items will not be completed in a straight line (said differently, their timing is unknowable). On the other hand, I suspect investors who accept that reality will be rewarded over the long run.

That attractive risk-reward balance is the reason Wells Fargo is one of my largest positions.

Disclosure: Long Wells Fargo.

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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Comments

Praveen Chawla
Praveen Chawla premium member - 3 weeks ago

Wells Fargo is a great example of the negative power of misaligned incentives. The american corporate machine still incentivizes these kinds of behaviours. John Stumpf inspite of crashing the bus, walked away with an estimated $130 million.

The Science of Hitting
The Science of Hitting - 3 weeks ago    Report SPAM

Praveen - I think that's fair. Thanks for the comment!

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