U.S. Bancorp (USB) and Wells Fargo (WFC) both reported 2013 first-quarter earnings recently. Post-earnings, USB stock fell while WFC shares remained level. I believe both banks are attractive investments. Furthermore, I premise that the two financial institutions have remarkably similar fundamentals, business models and management style.
Perhaps U.S. Bancorp is just a smaller "chip off the old block?" In this article, we will explore that thesis.
U.S. Bankcorp Background
Minneapolis-based U.S. Bancorp is the parent company of U.S. Bank National Association, the 5th-largest commercial bank in the United States. The company operates 3,084 banking offices, 5,065 ATMs in 25 states, and provides a comprehensive line of banking, brokerage, insurance, investment, mortgage, trust and payment services products to consumers, businesses and institutions.
USB reported 2013 first-quarter earnings on April 16. It was a largely solid report. Nevertheless, the stock fell in response to the release, dipping to $32.72 a share by the close, and further on Wednesday. The stock had been trading about $34 before the announcement.
Here's a graph showing how both stocks have traded over the past year:
courtesy of google.com/finance
A Comparison of Key Metrics
Please find below summary tables and analysis comparing relevant fundamentals of U.S. Bancorp and Wells Fargo. It should be noted that Wells Fargo is a much larger banking institution: the market cap of WFC is 3.2 times that of USB.
2013 1Q Headline Numbers
The banks reported modest revenue declines, both year-over-year (YoY) and the sequential quarter. The top line item spooked some investors, fearing that slowing growth in the mortgage and commercial loan business portends bad times ahead.
U.S Bancorp acknowledged the slowdown by reporting that "new lending activity" totaled $57.3 billion in the first quarter versus $71.5 billion in the previous quarter. However, this 20 percent reduction was concentrated in the commercial side of the business. Mortgage and Retail banking new activity was down but 4 percent.
On the other hand, Wells Fargo reported that mortgage originations were down 13 percent, and new applications were down 8 percent versus linked quarter.
Both companies showed improvement in comparative diluted EPS, but Wells Fargo garnered a greater year-over-year percentage increase than U.S. Bancorp.
The expected forward dividend yields for both banks range around three percent. I utilized the projected annualized dividend for the second quarter (both banks have received Federal regulatory approval for it) divided by the recent price per share to compute the yield.
Headline Numbers Bottom Line: The banks reported modest revenue declines. Wells Fargo revenues are evenly split between Net Investment Income and Non-Investment Income. The U.S. Bancorp spread versus fee income shows a 56% / 44% split. Year-over-year earnings grew at USB and WFC, but Wells offered investors a greater increase. The linked quarterly figures were about the same. Second quarter dividends are expected to bump up. The new cash dividend declarations will begin to place both institutions' payout ratios into the target ranges management set: between 30 and 40 percent.
Future dividends should grow in-line with EPS growth. Wall Street forecasts these two banks to grow earnings about 7 to 8 percent per year in 2013-14.
Differences between U.S. Bancorp and Wells Fargo headline figures are relatively small, perhaps favoring Wells Fargo slightly in some categories.
Other Measures and Ratios
Currently, U.S. Bancorp puts up a better number than Wells Fargo for key drivers RoE and RoA. The two companies are neck-and-neck and at the top of the heap for large banking in this important area. Wells Fargo has shown greater improvement sequentially and YoY versus U.S. Bancorp.
Net Interest Margin
NIM is a performance metric that examines how successful a firm's investment decisions are compared to its debt situations.
Both banks have identical NIM. The margin has eased for most banks over the past year or so, but this was expected in today's low-interest environment.
Tier One Common Equity
This ratio is a measurement of a bank's core equity capital compared with its total risk-weighted assets. It is the measure of a bank's financial strength. Regulators use the Tier 1 common capital ratio to grade a firm's capital adequacy. To be considered "Well-Capitalized," a hurdle of six percent is required.
Both banks easily meet the benchmark. In large part, this is why banking regulators have approved recent plan requests for significant capital returns for shareholders. Return of capital typically refers to cash dividends and share repurchases.
Basically, the Efficiency Ratio is a measurement of a bank's overhead as a function of its revenues. Overhead expenses for a financial institution do not include interest expense. It's a good overall metric to compare how well management is controlling costs. A lower ratio is better.
U.S. Bancorp sports a better Efficiency Ratio than Wells Fargo. It should be noted that WFC management had previously set a target range of 55 to 59 percent. Senior leadership has instituted a clear effort to reduce overhead. Wells has made their mark. USB is a smaller bank; its management has driven this metric down to best in class.
Net Charge Off Ratio
This ratio measures the amount of debt that a company believes it will never collect compared to average receivables. Debt that is unlikely to be recovered is often written off and classified as gross charge-offs. If, at a later debt, some money is recovered on the debt, the amount is subtracted from the gross charge-offs to compute the Net Charge Off value.
Both banks offer low NCO rates. Wells Fargo management indicated the bank's current ratio is the lowest it's been since 2006. U.S. Bancorp is right there with them.
To add some color the narrative, I've taken a few slides from the recent earnings report presentations for both banks to highlight some of the foregoing.
First two slides from the USB 2013 1Q report:
Next, three slides from the WFC first-quarter presentation (pdf):
(click to enlarge)
Other Measures and Ratios Bottom Line: U.S. Bancorp actually beats Wells Fargo on key return metrics and Efficiency, though Wells has shown greater recent improvement in these measures. Both banks are considered Well-Capitalized, have post-financial crisis low NCO rates, and have identical Net Interest Margins.
There is but a small degree of separation between the two institutions; perhaps an edge going to U.S. Bancorp.
I will utilize F.A.S.T. Graphs to demonstrate the relative valuation of U.S. Bancorp and Wells Fargo. Please compare two 10-year charts, both set to highlight diluted earnings per share. First, USB:
Indeed, U.S. Bancorp appears to be significantly undervalued. Note how the black line (price) tended to follow the blue line (normalized Price / Earnings ratio of 13.9x) up until 2011. Price and earnings decoupled at that time. If the 2013 EPS forecast of $3.07 is attained, and the stock returned to its historical multiple, a target of about $43 would result. This indicates the shares are currently undervalued by 32 percent.
Wells Fargo is likewise undervalued historically. The Normalized P / E ratio is about 14x. The stock trades at a multiple of a little less than 11x now. The gap between the black line (price) and blue line (historical P/E) suggests the stock is undervalued by some 38 percent, assuming the forecast 2013 EPS $3.66 is correct.
It should be noted that neither bank has missed a quarterly EPS forecast in more than three years. Both banks are expected to grow earnings in high single-digits over the next two years.
U.S. Bancorp, though a third of the market cap of big sister Wells Fargo, possesses remarkably similar business metrics. By most key measures, these two institutions rank at or near the top of the banking industry. Despite solid post-crash corporate performance, the stock price has not caught up with earnings: while diluted earnings now exceed pre-financial crisis levels, the market multiple has been compressed since 2011.
Future earnings forecasts indicate good forward growth prospects even in an uncertain economy.
Wells Fargo currently offers investors a higher dividend; however, both banks have been aggressively petitioning regulators to return capital. Thus far, the Feds have approved such management requests.
USB and WFC retain conservative management teams. The business models have changed little since the pre-2008 days: grow customer deposits, make consumer and commercial loans, collect banking fees, and run the business efficiently. Neither bank has a large global footprint, preferring to center the business here in the United States. There are no large trading desks, or obscure financial product offerings. These banks emphasize Main Street banking services, not Wall Street financial engineering.
I believe that Wells Fargo is the best-of-breed. However, after this analysis, I contend that U.S. Bancorp is but a "chip off the old block," and likewise an investment worthy of consideration.
Please do your own due diligence prior to making any investment. Good luck on all your 2013 investments.