Wells Fargo: Jump At The Opportunity

| About: Wells Fargo (WFC)

Summary

At 11x 2016 earnings, the stock is cheap.

Rising interest rates will help improve Net Interest Margin.

Q3 and Q4 were good. Mr Market is giving us a good opportunity to buy at the moment.

Wells Fargo (NYSE:WFC) has hovered around the $50 mark for the best part of 5 months now. Since then we've read 2 good earnings reports, and witnessed the first of many interest rate hikes from the Fed. Currently trading at $47, the stock sells for a mere 11x this years' earnings, is now the right time to buy Wells Fargo?

Q3 Highlights

Net income was up 1% to $5.8 billion compared to the same period last year. Diluted EPS was $1.05 for the quarter, and revenue was $21.9 billion, both up 3% Y/Y. Total average loans of $895.1 billion was up 7% in just 12 months, and quarter-end loans of $903.2 billion was an even more impressive 8% improvement Y/Y. Total average deposits were $1.2 trillion, $71.8 billion higher than the same period last year, or 6%.

Nonaccrual loans were down 14% or $1.8 billion, a huge improvement in just 12 months. A nonaccrual loan is a non-performing loan (where the debtor has not paid their scheduled payment for at least 90 days) that is not generating the stated interest rate because of non-payment from the borrower. There was no reserve release for the quarter, compared to $300 million last year, but net charge-offs did increase $35 million to $703 million. Net payout ratio to shareholders increased to 60% from 54% in Q2, and the equity ratio, which measures the portion of total assets financed by shareholders, fell from 57.7% to 56.7%.

Of course, not all news was good news. Net Interest Margin of 2.96% was down from 3.06%, Return On Assets (ROA) of 1.32% was down from 1.4% and Return On Equity (ROE) was down from 13.1% in Q3 2014 to 12.62% a year later.

Today we heard that the 30 year fixed mortgage rate has dropped to 3.5%, barely above the all time low set back in 2012. Amazingly, mortgage rates have started to fall since the Fed raised rates back in December. We started 2016 with the 30 year mortgage rate above 4%, and it was even higher than that in the summer of last year. This gives buyers more power, as monthly payments will be lower, allowing potential buyers to purchase more expensive houses as they qualify for the more valuable homes, which could push house prices even higher.

Housing inventory was down 4% to 3.9 months supply, the lowest since 2005, but the United States is building far fewer houses now than then, further fueling the increase in house prices, as demand remains strong.

The combination of low supply, near record low mortgage rates and increased demand is pushing house prices much higher, which could be great news for Wells Fargo in the next few years. Once increased Federal Fund rates filter through to mortgage rates, the bank will be able to charge higher mortgage rates on mortgages with a higher value, because of the rise in house prices. This of course will not happen over night, but in the next few years we could begin to see a substantial increase in WFC's bottom line.

Non-interest income

Lower gains from trading activities, debt securities gains, trust and investment fees and seasonally lower corporation insurance fees were offset by higher investment gains, improved deposit service charges, lease income and card fees; resulting in a $400 million increase in non-interest income to $10.4 billion compared to Q2 2015.

In Q3, 51.7 million shares were repurchased, and dividends per share were raised to $0.375 from $0.37 a year ago.

I expect management to use the current low share price to buyback more stock, and reduce the number of outstanding shares at a faster rate than we have seen. This could potentially increase the dividend per share even more, which means us patient investors can enjoy a generous yield while we wait for earnings to increase in the future.

Full year 2015 highlights

Net income of $23 billion was no better or worse than the year before, but EPS was up 1% to $4.15, due to the buyback. Revenue increased 2% to $86.1 billion, and there was a 3% rise in pre-tax pre-provision profit (PTPP) to $36.3 billion. A total of $12.6 billion was returned to shareholders through dividends and share repurchases, and this year's dividends will be higher due to the hike at the end of Q3.

Conclusion

Wells Fargo is making important steps in the right direction. Net Interest Margin will rise with higher rates, substantially increasing interest charges on mortgages. The bank continues to repurchase shares, and increase dividends, which will increase the already impressive 3.2% yield. Earnings Per Share continues to grow, as does revenue, but the market has not appreciated this growth, as the stock is currently at levels that we haven't seen for over a year. I think now is the time to take advantage, and start building or adding to a position around the $47 mark. It will take time for Fed rate hikes to filter through to the bottom line, but patient investors can enjoy the dividend, and buy this bank at a very reasonable price.

Disclosure: I am/we are long WFC.

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.