Back on October 19, 2012, I published an article suggesting investors reduce long-equity exposure to shares of US Bancorp (USB). The share price of the firm then declined substantially. Unfortunately, I didn't publish a follow-up article suggesting investors increase long-equity exposure: The share price increased since the dip in the fourth quarter of last year.
With the end of the first quarter of 2013 nearing, investors need to know if they should increase or decrease long-equity exposure to US Bancorp. If we can accurately forecast the share price in the coming quarter, we can improve risk-adjusted portfolio performance.
To assess what we should do with shares of US Bancorp, we are going to examine the financial performance relative to the industry. Also, we'll take a look at US Bancorp's operating segments. Further, we'll discuss cash flow from operations, the dividend and retained earnings. Then, we'll cover the 2013 forecast, the valuation, and the relative valuation. Finally, we'll conclude this report with an investment recommendation and suggestions for further research.
Investors should reduce long-equity exposure to common equity shares of the firm as the short-term valuations are extended and the forward valuations do not justify the current level of the share price. We'll begin by discussing US Bancorp's historic financial performance and how it compares with other firms in the industry. We'll also cover the firm's operating segment performance.
Financial Performance and Operating Segments
In order to gain perspective on where the company came from to reach where it is today, we'll examine the financial performance between 2003 and 2012. We'll go from total interest income down to net income applicable to common shareholders including most of the major lines on the income statement. That said, US Bancorp operates within the financial services industry, and we'll compare its historic performance to that of its competitors so that we can gain perspective on how well the firm is performing.
Between 2003 and 2012, total interest income increased at a nominal compound rate of 4 percent. Net interest income increased at a 5 percent pace. Total non-interest income increased at a 6 percent pace, and net income applicable to common shareholders increased at a 4 percent pace.
Bank of America's (BAC) gross interest income increased at a 7 percent annual pace. Net interest income increased at an 8 percent pace. Non-interest income increased at an 11 percent pace, and net income applicable to common shareholders declined.
JPMorgan Chase's (JPM) interest income increased at a 10 percent annual pace. Net interest income increased at a 15 percent pace. Non-interest income increased at an 11 percent pace, and net income applicable to common shareholders increased at a 13 percent pace.
Wells Fargo's (WFC) total interest income increased at a 10 percent pace. Net interest income increased at about a 13 percent pace. Total non-interest income increased at about a 15 percent pace, and net income applicable to common shareholders increased at a 13 percent pace.
US Bancorp grew slower than the peers used in the comparison. JPMorgan Chase and Wells Fargo grew at the fastest pace followed by Bank of America. Also, recently total interest income for the big banks has been declining while US Bancorp's total interest income has been increasing. Thus, we'll see if the big banks can maintain their pace of growth or if they slow to roughly US Bancorp's pace.
US Bancorp's net income attributable to common shareholders from every operating segment, except wealth management and security services, has been trending higher.
There may be an issue with the comparability of the banks; the comparability of most businesses is difficult as businesses usually have distinguishing features. The comparison is meant to be general.
All of that said, US Bancorp was the worst performing financial institution between 2003 and 2012. Next, we'll cover US Bancorp's cash flow from operations, dividend history and retained earnings rate.
CFO, Dividends, Retained Earnings
Analyzing cash flows is an essential element of equity analysis. In addition to taking a look at cash flow from operations, we'll look at the dividend history and the retained earnings history.
Between 2008 and 2012, cash flow from operations trended higher. In 2008, CFO was $5.3 billion and increased to almost $8 billion in 2012. Cash flow from operations peaked in 2011 at $9.8 billion.
Between 2003 and 2012, the dividend declined at an annual pace of 1 percent. Since 2010, the dividend has been trending higher. I expected the dividend to continue to trend higher and reach between $0.90 and $1.10 in 2013.
In 2003, and heading into the financial crisis, the retention rate, earnings per share minus dividends per share, was between roughly 50 percent and roughly 60 percent. Since the financial crisis, the retention rate has been above 80 percent; the rate declined to 73 percent in 2012. Personally, I would like to see the retention rate at roughly 65 percent. If 2013 EPS is $3-share and the 2013 dividend is $1-share, the retention rate would be 66 percent.
We are seeing increasing CFO, increasing dividends per share, and a declining retention rate; those are bullish for the share price of US Bancorp. These factors confirm the bull market for shares of US Bancorp. Next, we'll cover my 2013 financial performance forecasts.
Another essential element of equity analysis and equity valuation is forecasting financial performance. In this section, we'll discuss my forecast for US Bancorp's 2013 financial performance.
I'm forecasting 2013 total interest income in the $12.24 billion to $13.4 billion range. Net interest income should be in the $9.79 billion to $11.39 billion range. The range for total non-interest income should be $9.5 billion to $9.79 billion. Net income applicable to common shareholders should be between $4.82 billion and $5.93 billion.
This year should be a year of strong financial performance for US Bancorp. That said, I did include, in my forecasts, the possibility of a decline in total interest income in 2013. In the section to follow, we'll use the 2013 forecasts to create a forward valuation.
To value common equity shares of US Bancorp, we'll use the multiplier model valuations. I'll apply the 2013 forecasts to the multiplier models and develop forward multiplier model valuations.
My current share price-interest income ratio is 5.04. The forward price-interest income ratio is between 4.62 and 5.06. My current price-net income ratio is 12.06; the forward price-net income ratio is between 10.45 and 12.84. The share price used in the forecasts is $34.41.
On a price-interest income ratio basis, US Bancorp is overvalued. We are in an economic expansion; given that, US Bancorp is fairly valued to overvalued on a price-net income basis. On a short-term basis, the firm is overvalued. On an absolute basis, the firm is overvalued or at least at the very high end of fairly valued. I'll conclude this report with an investment recommendation and topics for further research.
Shares of US Bancorp are overvalued; while the firm is outperforming financially during this economic expansion, since 2003, the financial performance has lagged. Thus, given the current valuation and forward valuation, investors should reduce long-equity exposure to shares of US Bancorp.
Investors may want to do more research on the firm's financial performance to see if they should accumulate shares during, or following, a decline in the share price. Subsequent research should include aspects of the firm's financial position.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.