Wells Fargo & Company: A Worthwhile Investment

Jul.10.14 | About: Wells Fargo (WFC)

Summary

In comparison to other global banks like Bank of America and Citigroup, Wells Fargo has been paying very attractive dividends in the past five years.

Wells Fargo is attempting to improve its operations and plans to merge two units focused on corporate asset based lending.

The price of the stock is set to rise and may cross $60 and approach $70.

Wells Fargo & Company (NYSE:WFC) is a nationwide, diversified, community-based financial services company with $1.5 trillion in assets. It is the 29th largest corporation in the US, according to Fortune's 2014 rankings. With 9000 locations, 12,500 ATMs, and offices in 36 countries, Wells Fargo is the fourth largest bank, based on assets, and serves one in three households in the United States. It has gained various recognition awards for its CSR and was ranked the World's 35th most admired company by Fortune. Moreover, according to the Chronicle of Philanthropy, the company was named America's No. 1 "Most Generous Cash Donor" in 2013. The purpose of this article is to assess this stock from an investment perspective and in comparison to other players in the banking industry.

Financials

In comparison to other global banks like Bank of America (NYSE:BAC) and Citigroup (NYSE:C), Wells Fargo has been paying very attractive dividends in the past five years. The company's dividend yield is even more impressive in relation to its peers because it offers a dividend yield of 2.39%, whereas Citigroup and Bank of America investors are receiving dividend yields of 0.08% and 0.26%, respectively.

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Source: Wells Fargo Website and Y-charts

Wells Fargo is a healthy financial institution rising on the back of economic recovery and its cautious approach towards operational risks and regulatory requirements. The stock is also riding a roller coaster and year-to-date has appreciated in terms of price by almost 16% leaving behind all of its peers.

Source: Y-Charts

Focused on Asset-based Lending

Wells Fargo is attempting to improve its operations and plans to merge two units focused on corporate asset-based lending. Since the economy has started its recovery, the lending business has started picking up and to fulfill the demands of customers, Wells Fargo is merging its two units, business finance and business credit, to expand its business. After the merger of the two units, the same staff will be handling asset-based lending deals both below and above $35 million, which were previously handled by separate staffs. The new unit will increase the headcount due to the enormous growth of the lending business. The focus of the new unit will be well diversified and will expand to four core regions rather than the two of the previous credit units. It will be months before the changes are expected to take place.

The two units that will be merged will still fall within the wholesale banking unit, which contributed 29% to the company's revenues in 2013. Some of the unit's business highlights are shown below.

Source: Wells Fargo Presentation 2014

Wholesale loans and deposits have seen tremendous growth in recent quarters and this is indicated in the charts below. In the most recent quarter, loans went up 7% year-over-year in contrast to the 17% rise in total deposits over the same time period.

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Source: Company Presentation

Wholesale Banking Credit Quality: Net Charge Offs as a Percentage of loans

Wells Fargo has enhanced the credit quality of its wholesale banking unit as indicated by the deteriorating charge-offs as a percentage of loans.

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Source: Company Presentation

Lawsuits

Wells Fargo is also facing a Federal Housing Administration (FHA) lawsuit, filed in a Manhattan federal court in October 2012 concerning substandard mortgages made by the bank ending up in defaults covered by the agency's insurance. Incautious origination and underwriting of loans cost FHA hundreds and millions of dollars in insurance claims. Three other banks, including Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. (NYSE:JPM), decided to settle matters with the Justice Department and paid a total of almost $2 billion to resolve complaints similar to the one Wells Fargo decided to fight.

Note that Wells Fargo is being accused by the FHA of committing additional crimes related to the mortgage crisis. Wells Fargo failed to convince federal appeals court that a multi-bank mortgage settlement in 2012 restricts the government from suing the bank again for wrongful home lending practices and thus, the court upheld the lower court's ruling of rejecting the bank's bid for dismissal in September.

The recent progress in the case has increased the likelihood of a settlement in the New York lawsuit by the bank. Whether the bank settles the case or not, the important thing is the bank has learnt a lesson from this bitter experience and has focused itself on quality lending. It has been ameliorating its operations and risk control measures to avoid such a mishap in the future.

Bottom Line

The following table sums up the comparison of Wells Fargo to Bank of America and Citigroup in terms of price multiples. Based on PE multiple, Wells Fargo and Citigroup both stand at the same multiple and are undervalued, compared to industry. The same is the case with all other multiples, according to which the stock is undervalued. Assuming that the stock's multiples will revert to industry averages over time, Wells Fargo's PE will turn to 13.54, which will be the case if price goes up or earnings go down. The latter option is not plausible because Wall Street has reached a consensus estimate of $1.01 EPS for the fiscal second quarter; the actual earnings are due to be released in the second week of July. If the company manages to match the consensus estimate for its EPS, its stock price should reach $54.That means the price of the stock is set to rise and may cross $60 level and approach $70 in a year or so.

Source: Reuters

The company has been offering an enviable dividend yield and better EPS growth rate in the past five years. Therefore, I will give this stock a buy rating.

Disclosure: The author has 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 a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.