While I am typically more bullish on larger financials than smaller ones, comparing U.S. Bancorp (USB) to Wells Fargo (WFC) challenges my traditional pattern. I find that the market has already priced in much of Wells Fargo's stellar fundamentals, but have not fully appreciated those of U.S. Bancorp. The latter is heading for outperformance due to its stability and certain outlook for capital allocation. Both companies are rated around a "buy" on the Street, but U.S. Bancorp is structurally positioned for more favorable risk / reward.
From a multiples perspective, Wells Fargo appears to be more expensive. It trades at a respective 10.9x and 9x past and forward earnings, while U.S. Bancorp trades at a respective 12.4x and 10.7x past and forward earnings. Bank of America (BAC) -- albeit the riskiest, with a beta of 2.2 -- is the cheapest of the three at 6.5x forward earnings. In my view it is one of the most undervalued banks. But since you cannot compare financials that so differ in size and accounting practices, this analysis is to be taken with a grain of salt. Keep in mind though that Wells Fargo has strong liquidity with net debt of $19.5B representing only 12.7% of market value. Even still, I remain more confident that management of U.S. Bancorp will increase dividend and buyback activity due to solid returns on all key fronts.
At the third quarter earnings call, U.S. Bancorp's CEO, Richard Davis, noted stronger performance:
"And the overall credit quality of our portfolio continued to improve. We had excellent deposit growth, and gained market deposit -- market share. We grew both our balance sheet and our fee-based revenues, and attained record total net revenue. We realized positive operating leverage and earned record net income. Our capital and liquidity position remained strong and growing. We were able to return 45% of our earnings to our shareholders, and we once again achieved industry-leading performance metrics. All of this, despite the challenges of a difficult and uncertain economic environment, further demonstrating the value of our company's diversified business model, prudent approach to risk management and sound growth strategies…
On one hand, we're managing our business through a difficult and complex environment, which includes a fragile economy, increasing regulatory oversight, reputation risk and competitive pressures. On the other hand, we're providing our customers, consumers, small businesses, large corporations, institutions and government entities with the products and services they need to achieve their own financial goals".
With relatively predictable earnings, a Tier 1 Common Ratio of 8.5%, double-digit ROE, and strong credit quality, we can only expect capital allocation to get more aggressive. Management is targeting upward of around 80% of cash to be returned to shareholders. Moreover, average loans are expected to expand by more than 8% in 2012 and the bank has less exposure to Europe relative to peers. While credit card fees will further boost earnings, commercial and residential mortgages are yielding high-risk adjusted returns.
Consensus estimates for U.S. Bancorp's EPS are that it will grow by 27.6% to $2.82 and then by 14.9% and 10.8% more in the following two years. Of the 6 revisions to estimates, 5 have gone up for a nominal change. Assuming a multiple of 12.5x and a conservative 2012 EPS of $3.14, the rough intrinsic value of the stock is $39.25, implying 34% upside. If the multiple were to decline to 9x and 2012 EPS turns out to be 6.8% below consensus, the stock would fall by 7.2%.
This is not so much the case for Wells Fargo (see here). The bank is particularly exposed to regulations and faces a poor transaction environment. While loan growth and credit trends may further improve, capital allocation remains uncertain. Recent past issuance of shares has diluted EPS. The use of cash to purchase European bank assets may contribute to yet more risk at the most vulnerable time. With that said, Project Campus will cut costs and raise the probability of greater buyback activity. Expectations are that it will lower quarterly expense runrate by around $1.5B to $11B. In addition, Wells Fargo has loyal customers in commercials and will easily maintain an acceptable Tier 1 Common Ratio (Basel III) of 8%.
Consensus estimates for Wells Fargo's EPS are that it will grow by 27.6% to $2.82 in 2011 and then by 14.9% and 10.8% more in the following two years. Assuming a multiple of 11x and a conservative 2012 EPS of $3.18, the rough intrinsic value of the stock is $34.95, implying 19.4% upside.