Why Wells Fargo Is Heading To $60

|
 |  About: Wells Fargo & Co. (WFC)
by: Wall Street Playbook

Summary

The bank continues to focused on what it does best.

There’s a premium placed for banks with above-average growth prospects that still meets certain criteria of safety.

Investors should expect 12-month gains of 20% as the bank is expected to return more than last year’s $11.4 billion to shareholders this year, including dividends and buybacks.

There's a saying, "different is not necessarily better." But Wells Fargo (NYSE:WFC) continues to demonstrate why it stands in a class of its own among the four true megabanks.

Unlike peers JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C), which engage in risky businesses such as proprietary trading and elaborate derivative books, Wells Fargo relies more on its consumer and business demand for loans and other services.

Management has grown the bank to become the No. 1 mortgage originator in the U.S. And despite industry-wide headwinds, the bank's first-quarter results show that Wells Fargo benefits from a well-diversified operation. And given signs of an improving credit environment, these shares may yet be a bargain, despite resting near 52-week highs.

Friday, Wells Fargo reported a profit of $5.9 billion, which grew 14% year over year and beat analyst estimates of $5.1 billion. On a per share basis, this amounted to $1.05, well ahead of estimates of 96 cents.

As noted, the improving credit quality helped to offset a decline in mortgage banking. This continues the bank's streak of record quarterly profits, which dates back more than three years. More importantly, Wells Fargo's results highlight the strong advance in the U.S. economic recovery and housing market.

The bank posted revenue of $20.6 billion, which fell 3.4% year over year from $21.3 billion. As with other banks, including JPMorgan, which posted an 8% revenue decline, Wells Fargo's revenue have suffered amid a slowdown in mortgage banking.

As interest rates have risen, fewer customers have chosen to refinance their mortgages. To offset this weakness, management has worked to reduce costs, including reducing the bank's workforce by the thousands. 1,100 jobs were eliminated in the first quarter.

In Wells Fargo's community banking business, its biggest division, the bank reported a profit of $3.8 billion, a 31% increase year over year. This offset a 15% decline in its wholesale banking unit. There's concern that this decline points to Wells Fargo's market-share loss in investment banking to JPMorgan and Bank of America. Again, that's where the differentiation comes in.

The bank showed a 7% jump in business lending. Likewise, growth was seen in area like auto loans and credit cards. In fact, Wells Fargo originated $7.8 billion in auto loans, a 15% year over year increase.

The bank continues to focus on what it does best. As it stands, Wells Fargo enjoys over 25% share in mortgage market and exceeds 5% share in auto loans. Not to mention, the bank is well positioned in under-appreciated markets like crop insurance. These are areas where management can use its wide customer reach to promote other areas of its business such as asset management and specialty lending.

All told, as Wells Fargo continues to demonstrate solid execution and leverage, the bank still has value-creating opportunities to uncover. What's more, the bank's business is exceptionally sound.

Finally, 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. Unlike Citigroup and JPMorgan, which has significant exposure overseas, Wells Fargo does not carry the sort of risks that this level of exposure presents, particularly in unstable overseas markets like Europe.

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. When you consider that the bank is expected to return more than last year's $11.4 billion to shareholders this year, including dividends and buybacks, 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. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. 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.