Wells Fargo: Trading Below Fair Value

| About: Wells Fargo (WFC)

Summary

In 2015 Wells Fargo performed much better than the competitors.

The company has managed to raise its mortgage credit portfolio, as well as taking a sweet piece of student loan market.

The intrinsic price of Wells Fargo is around $60 whereas it's trading at around $50 (it's cheap).

The interest rates hike by FED, which we witnessed recently, can become a real stress for the companies in financial sector (mainly because of the possible bank loans volume decrease and the uncertain dynamics of interest rate derivatives, which most banks possess). In this situation looking for just a good company with a stable cash flow is not enough. We should take a look at the companies with a lower interest rate risk. And one of such companies is Wells Fargo (NYSE: WFC).

The previous year wasn't the best for financial sector: high volatility and global credit portfolio worsening adversely affected the U.S. banks' capitalization. The revenues of Citi (NYSE:C), Goldman Sachs (NYSE:GS), Bank of America (NYSE:BAC) and Morgan Stanley (NYSE:MS) decreased by 5.1%, 7.6%, 12.9% and 15.7% respectively. But even after the Q1 2015 Wells Fargo performed much better than the competitors: the revenue shrank only by 4.9%. Good Q3 2015 & Q4 2015 also speak in company's favor.

The company has probably been undervalued since July-September 2015, when the financial sector faced the losses at Asian and American security markets and the $1.5 billion decrease in demand for credits from Chinese companies. The main reason why the company is still undervalued is investors' disbelief in the U.S. & Global economy growth. As Jesse Lubarsky, a trader of financial stocks at Raymond James, puts it:

We need a better economy, we need loans to grow, you can't invest in [the] group if you can't invest in an economy going higher.

I'd call this situation for Wells Fargo as "a good company in bad times": temporary difficulties the company faced made the stock cheaper than it should be. And as long as the market doesn't believe in the U.S. & Global economy growth, WFC will stay lower than it should be.

Key drivers of growth

Wells Fargo is one of the largest financial conglomerates of the U.S. with a special place at mortgage market (in fact, WFC is the second-largest mortgage bank in the U.S.). The credit portfolio of the company is $863 billion worth, whereas the deposit portfolio is around $1200 billion. That being said, the company is sensitive to the dynamics of long-term interest rates, especially to the mortgage rate.

In the recent past, when FED kept the rates unchanged, the overall credit portfolio of Wells Fargo went up by 9% YoY (or by 4% comparing to the previous quarter).

As follows from Q3, they managed to keep the positive dynamics going: the overall credit portfolio increased by 7.7% compared to Q2. The amount of C&I loans increased by 15% compared to Q2 and now is $254.2 billion.

The main driver of company's growth is its mortgage portfolio. The bank has managed to . The conglomerate has also taken a sweet piece of secondary mortgage market: the volume of WFC transactions at the market is $55 billion compared to $48 billion in the previous year.

Another key sphere of company's development is student loans segment - the bank has become the second-largest student loan organization in the U.S. Although Wells Fargo has faced the investigation by CFPB over student loans, I suppose it won't hurt the company in the long run.

I assume that the positive dynamics of the metrics above is now followed up by competitors' step back at the mortgage market (the total volume of mortgage loans of the five largest U.S. banks decreased by 4.5% YoY).

Overall, the company has managed to keep its leading position at the mortgage market as well as developing its position at the student loans market. Now let's take a glimpse at Q3 2015 & Q4 2015 results.

Operational results & comparison to the peers

As for operational and financial results, the company looks much better than the competitors. Mainly, because of the positive dynamics at the mortgage & C&I markets, but partially because of reappraisal of reserve requirements. The key operational & financial metrics have shown some positive dynamics: the revenues increased by 3.2% ($21.9 billion), the total volume of credits increased by 7.09% (mainly, because of the C&I loans) and now is $903.2 billion, the total deposit volume increased by 6.37%.

Profitability metrics also look much better then the sector averages:

  1. ROE is around 12.7%, which is significantly higher then industry average ROE.
  2. ROIC is around 6.47% (the only bank that has a better ROIC is JPMorgan).
  3. ROA is about 1.2% (not high, but at least, not lower than the industry average).

Comparing the company's liquidity to the peers, Wells Fargo is at or better than the industry average. Q4 Quick ratio is 0.29 (industry average - 0.18), short-term debt ratio is 1.29 (industry average - 1.03). The turnover ratios are also much lower than those of other banks: the inventory turnover ratio is 0.91x, the asset turnover ratio is 0.98x.

Right now the company's trading lower it's 12-month P/E - about 12.4x. I assume that in case Wells Fargo manages to keep it up P/E can go down to 10.6x.

Comparison to main competitors

Since there are a plenty of banks in the U.S., we will compare Wells Fargo only to those with the same market capitalization, i.e. JPMorgan (NYSE:JPM) (market cap. of ≈ 212 billion), Citigroup (market cap. of ≈115 billion) and Bank of America (market cap. of ≈127 billion).

Click to enlarge

(Source: Morningstar.com)

As you can see from the tables, WFC looks decent. The P/S and P/B are the highest, but don't forget that this company is the biggest in the list. P/E is the highest, but as I have said the good perspectives at mortgage and student loans markets can make it go down to 10.6. Overall, company's looking at the industry level (again, considering the fact that WFC is the largest firm here (market cap. is ≈2.0x Citi's & BofA's), its valuation metrics doesn't look mediocre).

The firm's operating margin is the highest as well (which indicates the bank manages to make money out of its core business activity better than the firms) and high interest coverage ratio signifies that its ability to payout its total interest charges is higher than the competitors'. 5-yr Revenue CAGR is negative for all the firms, but Wells Fargo doing fine here (making its way only to Citi).

The only thing that may bother an investor is the D/E ratio of 8.02. It's quite high for most industries, but not for the financial sector: JPMorgan has D/E of 8.8, Goldman Sachs - 8.86, Morgan Stanley - 9.85, and again Wells Fargo looks pretty good.

Conclusion

Finally, I calculated the price of the stock using the DCF model. I conservatively assumed that the revenues will be growing at 3% until 2026, and under this assumption the company should be trading at $60, so as for now it's cheap.

Although the market may still push the stock lower, I still think Wells Fargo is a good long-term pick for the current price. At around $50 it's fundamentally undervalued and in future it can go up to $60/share, so it's high time investors considered buying this bank.

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.