It is a well known fact that Wells Fargo (WFC) is one of the largest holdings in the portfolio of Warren Buffett's Berkshire Hathaway [(BRK.A) (BRK.B)]. He has recently increased his stake again, and his total investment is now valued at around $19 billion. The shares have generated returns of around 29% over the last year which is 9% more than the S&P 500 but 8% less than the KBW Bank Index. The KBW Bank Index is a composite index comprising of 24 bank stocks, and is often used to benchmark the banking industry. However, the price-to-book value ratio of 1.51 and the price to tangible book value ratio of 1.93 are both higher than the average of the stocks in the KBW Bank Index. This article will address the issue of whether there is any further growth possible in the stock price.
At first glance, there does appear to be room for further improvement. The median target price of analysts is $45.00 a share, and the mean target price is $45.93, with a high and a low of $54.00 and $39.00 respectively. The shares currently trade at $41. However, in addition to discussing the comparison, we will need to investigate further in order to establish the potential growth prospects.
Second quarter finances
The company reported record net income for the quarter and the highlights are described as follows. Net income of $5.5 billion was up 19% and EPS at $0.98 per share was up 20% over the previous year. Reported revenue of $21.4 billion increased by $89 million while non-interest expenses of $12.3 billion were down $142 million over the same quarter of the previous year. Efficiency ratio improved from 58.2% to 57.3%, return on average assets (ROA) of 1.55% up 14 basis points, and return on equity (ROE) of 14.02%, up 116 basis points; all compared to the same quarter of the previous year. Quarter-end loans were $802 billion, up by $26.8 billion and quarter-end core deposits were $941.2 billion, up by $59 billion. Capital grew in the second quarter, and Tier 1 common equity of $117.6 billion under Basel I amounted to 10.73% of risk-weighted assets, compared with 10.08% in the previous year and 10.39% in 1Q13. Under the Basel III capital rules effective as of July 2, 2013, the Tier 1 common equity ratio was estimated at 8.54%.
Wells Fargo and American Express (AXP), announced a new partnership in terms of which Wells Fargo will issue new credit cards that will be accepted on the American Express network. The financial terms have not been disclosed. Wells Fargo said that this move was in line with the strategy to expand the credit card business and to offer customers a choice of a variety of credit cards. The company will run a pilot program in select U.S. markets commencing with the 3Q13, with a full scale launch scheduled for the first half of 2014. This opens the door to expanded income streams from the card business. Currently, only one-third of Wells Fargo customers own a Visa credit card giving it plenty of room to expand its credit card offerings. Moreover, the average spend on an Amex card annually is $15,000 compared to only an average of $1,000 for Visa, and Wells Fargo should profit from the increased spend.
The mortgage business, in which Wells Fargo is the largest player in the country, will also undergo changes. For one thing, the company is withdrawing from its eight joint ventures because regulation is increasingly making it difficult to continue operating in joint ventures. The company is also staying in control of its staffing levels and costs, and will cut 2300 jobs in the mortgage business because of the decline in refinance caused by the increase in long-term interest rates. The Mortgage Bankers Association said that its Refinance Index had declined 62% from the peak in May, and that mortgage loan applications for the week ended Aug. 16 declined 4.6% from the previous week.
Growth in Asia
Wells Fargo is going to increase the number of fund-services clients in Asia by almost 20% every year, and currently has 20 clients receiving its fund services in Asia made up of hedge funds, traditional, private-equity, and hybrid funds. The growing opportunities in the emerging markets in Asia have attracted plenty of major banks, and presently accounts for around 15% of Wells Fargo's global fund services revenues. It is planning to enhance its operations, particularly in Hong Kong, where it sees opportunities and is going to open a new office there. The region is also seeing a boom in bond sales which have totaled $1.8 trillion since the beginning of 2012. Wells Fargo presently has 40 people in the division operating from Singapore.
Wells Fargo has at least two of the major ingredients required for the Warren Buffett investment, namely quality management and a simple uncomplicated business model. It has resisted the excesses of its banking peers such as complicated things like derivatives, and withdrew from sub-prime mortgage lending well before the bust. Inevitably, because of its size, it has its legal problems, but nothing on the scale of its contemporaries. We believe that the current price undervalues the stock given the P/E (TTM) of 11.13 times and the return on equity of over 13% compared to the industry average of 9.36%. Any anchor stock in the Berkshire Hathaway portfolio certainly deserves to be in your portfolio and we would recommend a "buy."