Buy Wells Fargo Ahead Of Earnings

| About: Wells Fargo (WFC)


Can Wells Fargo return to loan growth?

To what extent can cost-cutting unburden weakening revenue?

Unlike most of Wells Fargo's rivals, management has figured out ways to produce meaningful returns in both assets and its investments.

The prevailing question for Wells Fargo (NYSE:WFC) continues to be "where has all the growth gone?"

Given the highly competitive nature within this sector, including a resurgent Bank of America (NYSE:BAC), investors are unsure of what to make of Wells Fargo's recent decline. But has it been really that bad?

In areas such as mortgage lending, which has been the bank's biggest area of strength, Wells Fargo's performances haven't been that bad. Nonetheless, the double-digit sequential decline in loan originations is something that management must reverse.

By contrast, even though Bank of America showed a sequential weakness in mortgage banking, its results still arrived in-line with Street estimates. Wells Fargo will report first-quarter earnings Friday, and investors will look for assurances that this is a company they can still bank on.

Wall Street is optimistic. Analysts are looking for a profit of 97 cents per share, which would represent a 5.4% increase on a year over year basis. Over the past three months, the consensus estimate has risen from 94 cents. For the full year, analysts are projecting earnings of $4.05 per share.

In terms of revenue, analysts are calling for a 8% drop to $20.60 billion. Last year, Wells Fargo reported revenue of $22.41 billion. For the year, revenue is expected to come in at $84.28 billion. As noted, investors have inquired about the company's growth. This is because Wells Fargo has posted a decline in each of the past four quarters, including a 3% drop in the January report. And a 4% drop in the quarter before that.

But Wells Fargo has made up for this shortfall in earnings. Through diligent cost-controls, the company has posted increasing profit for three quarters. The 8% year-over-year growth in net income in the most recent quarter came after the 13% profit growth in the third quarter and the 19% rise in the second quarter. And from my vantage point, this is the main metric that matters in the near term.

What's more, the bank's business is exceptionally sound and safe. Unlike Citigroup (NYSE:C) and JPMorgan (NYSE:JPM), which have significant exposure overseas, Wells Fargo does not carry the sort of risks that this level of exposure presents, particularly in weak markets like Europe.

Wells Fargo consistently demonstrates solid execution and leverage. Unlike most of its rivals, Wells Fargo's management has figured out ways to produce meaningful returns in both assets and its investments. This is despite prolonged weakness in interest rates. What's more, the bank continues to benefit from a business that is unburdened by unfavorable risk.

And this goes back to a situation where investors have to assess the risk/reward trade-off. Although loan growth has been weak, Wells Fargo still has a strong mortgage lending business. The soft loan activity is a concern. But it should not hurt future core operational growth, assuming that the bank generates 8% increase in loan balances.

The bank still owns a 30% share in the U.S. mortgage market, which far exceeds that of both Bank of America and JPMorgan. And this should help Wells Fargo remain a force in consumer lending. This means even amid periods of weakness, Wells Fargo will remain in good shape.

Finally, while most banks tend to fall in within the same category and are thereby appraised on similar standards and metrics, it is clear that Wells is out to set itself apart from the rest. There's a premium placed for banks with above-average growth prospects that still meets certain criteria of safety.

From that standpoint, Wells Fargo meets all of the requirements. From an investment perspective, the stock is trading at a considerable discount. The stock is currently trading at a P/E of 12, which is 3 points below the industry average.

Assuming that interest rates return to normal levels, which industry experts expect, Wells Fargo should return to consistent revenue growth. That, and the bank's efficiency improvements should boost profits. Investors should then expect gains of 20% as the stock should reach $60 per share in the next 12 to 18 months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's financial sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Money Center Banks, Earnings
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