Wells Fargo: A Strong Defensive Buy In A Volatile Market

| About: Wells Fargo (WFC)

Summary

WFC has a sustainable competitive advantage with wide distribution network, diversified revenue sources, large and low-cost base with sound management.

Wells Fargo has a cost advantage compared to its peers.

Accelerating loan growth and expense ratio improvement along with increasing interest rates to boost WFC profitability.

Wells Fargo & Company (NYSE:WFC)

Business description

Wells Fargo & Company is one of the four largest banks in the United States with well over $1 trillion in assets. The company is split into three segments for reporting purposes: community banking, wholesale banking and wealth, brokerage and retirement. The company is also a major player in the real estate market servicing more than $2 trillion in residential and commercial loans. Wells Fargo is the product of several different mergers including the acquisition of Wachovia in December 2008 and the 1998 combination of Norwest Corporation and Wells Fargo & Company.

Fundamentals (Financial year end 31st Dec)

Core loan growth continues at a moderate pace - End-of-period loans increased just over 6% to $916.6 bn and core loans jumped 8% y/y. Loan growth was largely driven by commercial and Wells Fargo had another quarter of broad-based lending growth driven by C&I (Commercial & Industrial) and residential mortgage lending while benefiting from the strong commercial real estate and auto loan growth. Given its continued focus on cross-selling and further strengthening its lending platform along with the integration of its GE Capital commercial distribution and vendor financing unit the bank is expected to experience mid-single-digit loan growth both in FY16 and FY17.

NII (net interest income) growth continues despite NIM (net interest margin) contraction - Deposit growth and increased debt balances offset increased income from variable sources and caused a 4-bp decline in the NIM to 2.92%. Despite that NII of $11.6 bn rose 4% y/y given broad-based asset growth and the increase in short-term rates at the end of the quarter. There can be modest pressure on margin going forward as long as low rates persist and higher cash balances weigh on results but its NII likely to increase as the bank continues to expand its balance sheet. Wells Fargo's management noted that should the Fed continue to raise rates the NII could grow in excess of 4% supporting earnings in a tough fee income generation environment.

Operating fee income decline partially offset by continued expense discipline - Wells Fargo's core fee revenues came in weaker despite strength in several line items, expenses also came in lower demonstrating the strength of Wells Fargo's franchise. The efficiency ratio remains low at 58.4% and is expected to decrease further and hence improve in FY16 and FY17.

Financials

FYE- Dec 31st

FY11

FY12

FY13

FY14

FY15

In USD mn

Net Interest Income (NYSEMKT:NII)

42,763

43,230

42,800

43,527

45,301

NII growth (%)

(4.46)

1.09

(0.99)

1.70

4.08

Non-Interest Income (NoII)

38,185

42,856

40,980

40,820

40,756

NoII growth (%)

(5.61)

12.23

(4.38)

(0.39)

(0.16)

Net Revenue

80,948

86,086

83,780

84,347

86,057

Revenue growth (%)

(5.00)

6.35

(2.68)

0.68

2.03

Net Income

15,025

17,999

20,889

21,821

21,604

Net Income margin (%)

20.03

22.50

26.53

27.99

27.20

EPS (GAAP)

2.82

3.36

3.89

4.10

4.15

Dividends per Share

0.48

0.88

1.15

1.35

1.48

Net Loans / Advances

750,259

782,514

807,784

850,232

905,014

Other Earning Assets

411,522

495,257

578,489

692,023

714,769

Total Assets

1,313,867

1,422,968

1,523,502

1,687,155

1,787,632

Total Debt

174,445

184,554

206,881

247,461

297,064

Total Equity

140,241

157,554

170,142

184,394

193,132

ROA

1.26

1.42

1.51

1.47

1.35

ROE

12.19

13.16

13.99

13.68

12.86

Click to enlarge

Key Value Drivers

  • Loan growth - Average loan growth for WFC is expected to accelerate from 6% in 2015 to 10% in 2016 on loan portfolio purchases and improving macro driving C&I, residential and consumer loan growth.
  • Expense ratio - WFC is expected to reinvest any savings from expenses back into company as continual investments in technology and compliance leave expense ratio at the higher end of WFC's range (55%-59%).
  • Home Prices - WFC's significant exposure to housing will drive lower 1st and 2nd lien losses and stronger residential loan growth as housing business continues to improve with growth in U.S. economy.

Major Risks

  • A sustained low interest rate environment would tend to tighten net interest spreads resulting in lower profitability margins.
  • Substantial competition exists in Wells Fargo's primary markets from state and national banks, thrift institutions, foreign banks, finance companies and other firms that provide financial and ancillary services.
  • Acceleration of credit deterioration could hurt earnings at Wells Fargo given the large exposure to consumer loans.
  • Banking regulations and regulatory intervention may change or regulatory actions could adversely affect Wells Fargo's competitiveness or limit its business opportunities.

Investment Rationale & Conclusion

In the current challenging operating environment, investors will be eyeing to get into quality names at opportunistic prices. Wells Fargo is expected to benefit from this flight to quality and hence at current levels represent an attractive buying opportunity. Wells Fargo's largely domestic footprint and its stable deposit base cushions it from the wider market turmoil which makes it an attractive defensive holding in the current volatile market.

Wells Fargo is using price as a competitive tool to take market share and hence solid loan growth is expected within its C&I and portfolio acquisitions providing much of the strength. As the bank invests in technology and compliance its efficiency ratio can slightly increase over the near-term but is well poised to control its expenses resulting in higher profitability over FY16 and FY17.

Wells Fargo & Company currently trades at $50.23 (closing price as on 1st Feb) with its 52 week range of $46.88 - $58.77 and looks attractive with strong potential upside over medium to long-term as outlined below -

  • Attractive dividend yield, strong long term track record of growth, profitability and sound risk management provides considerable scope to trade at higher valuations along with positive risk-reward trade off.
  • Diversified business model with opportunities for growth in several businesses and sizable share buybacks.
  • Medium term earnings expected to benefit from higher NII income led by rising interest rates and recent loan portfolio acquisitions.
  • Accelerating loan growth, expense rate improvement, rising home prices, improving consumer profile and rising interest rates scenario to enhance profitability driving its stock price upwards.

Disclosure: I/we 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.

Additional disclosure: (Sources: Company Annual Reports, Company Press Releases, Investor presentations, SEC Filings -Form 10-K, 10-Q, Morningstar, Reuters, Yahoo Finance)