- Positive loan book growth and 2015 net income of $23 billion makes Wells Fargo look very attractive especially considering its present valuation.
- Wells Fargo stock will always sell at a premium due to its earnings stability. Just because other banks in the US have cheaper valuations doesn't make them necessarily better investments.
- Wells Fargo is seeing strong growth in its commercial divisions. These loans are more profitable due to higher interest rates charged to customers.
Stocks like Wells Fargo (NYSE:WFC) always sell at a premium. It doesn't quite have dividend aristocrat status as it cut its dividend to $0.05 back in May 2009 but its fundamentals remain very strong and I see no threat to the dividend even if we go through another bear market in the near term. Ever since the great recession, the Fed has demanded much stronger balance sheets from US banks and this suits Wells Fargo just fine as it has always been risk adverse in its lending practices. Its latest set of earnings reported net income of $5.71 billion which was identical to Q4 2014 which was an achievement in itself because its NIM (Net interest margin) fell to an all time low of 2.92% last quarter. This explains why the 7% hike in its loan book last quarter didn't affect the bottom line so I would expect the bank's return on assets figure to rise this year as the Fed slowly creeps up interest rates which will positively affect Wells Fargo's Net interest margin. On a historical basis, the share price is undervalued and with the stock trading down 7%+ year to date, maybe now would be a good entry point especially if you are bullish on the US economy. Here are 3 strong reasons why I believe downside movement in the share price is limited.
Firstly you have to go to Wells Fargo balance sheet where you see the bank has over $19 billion in cash and long term debt of $199 billion. I don't foresee the debt being a problem when you consider that the bank brought in $23 billion in net income in 2015 and its loan book (which is an asset on its balance sheet) continues to increase and should reach $1 trillion in value sometime this year. The current dividend costs the bank over $7.7 billion a year or $1.93 billion a quarter but share buybacks were also used last quarter which meant $3.2 billion was returned in total to investors in Q4. The payout ratio in currently 59% which means there is still ample room for the bank to increase its dividend at the back end of this year. The one outlier is the Fed's stress tests which are due to reported in March of this year but I can't see Wells Fargo failing these stress tests especially when you consider the bank's record up to now and the risk-adverse business model the bank employs in its lending practices. Furthermore the bank finished 2015 with a common equity tier I ratio of 10.7% which is excellent as regulators look for at least 3%. This ratio compares the bank's risk weighted assets against its equity capital to ensure that a repeat of 2008, when financials got crushed, doesn't happen again.
I actually think Wells Fargo's pay-out ratio might even come down in the next few quarters due to new business about to come on stream from the GE capital acquisitions. Approximately $31 billion was acquired and 90% of this is expected to close by the end of Q1 2016. Therefore Wells Fargo's Q4 efficiency ratio of 57.4% will probably go up as a result of the added expense but again I see it as temporary. The GE acquisition will bring in more revenue which is what other banks (revenue growth) are finding very difficult to achieve in the current environment. An efficiency ratio around the mid 50's would be excellent for a bank such as Well's Fargo considering how risk adverse it is. Lower expenses combined with a higher NIM this year should definitely increase returns and the stock price accordingly in 2016.
Thirdly, this bank has always been noted for its profitability and with the growth of its commercial loan division in the fourth quarter, I see this trend continuing. Core loans grew by $62.8 billion (see chart) or 8% on a rolling year basis but the bank's commercial division represented $9.3 billion of Well's Fargo's loan book growth. Operating margins have always hovered around the 40% mark but this metric could easily increase if the bank keeps growing its commercial loan division which has higher margins than other loan types. Furthermore, average net charge-off levels seem to be under control as 0.36% was the number for the last quarter which was in line with Q4 2014. What investors need to consider here is that even when the bank was going through the great recession back in 2009, net charge off levels only reached 2.71% in Q4 2009 but the bank was still able to report a profit in that quarter. Takeaway? Wells Fargo is prepared for a slowdown in the US economy and will definitely be affected less than other banks in the US
To sum up, Wells Fargo is experiencing robust loan growth and has kept its peer leading margins throughout this difficult period for banks. If the US continues to tighten, Wells Fargo will do very well as I see its efficiency ratio coming down and its net interest margin increasing. Fourth quarter earnings illustrated the stability of this bank. Wells Fargo stock price will be less volatile than others due to its small exposure to capital markets but watch housing and car loan growth in the US. Loan demand in the US is crucial for Wells Fargo and I believe the energy bearish argument is over-hyped considering the bank's exposure in this area.