Compelling Buys: Wells Fargo And Fifth Third

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 |  Includes: FITB, WFC
by: Takeover Analyst

From regulatory headwinds to concerns over leverage, investors have been unreasonably hesitant about financials. However, Fifth Third (NASDAQ:FITB) and Wells Fargo (NYSE:WFC) both present a compelling case to buy now. Their abnormally high volatility will help drive risk-adjusted returns, as the fundamentals prove strong.

From a multiples perspective, Fifth Third and Wells Fargo are dirt cheap. Wells Fargo is the cheaper of the two - trading at a respective 11x and 8.6x past and forward earnings, with a dividend yield of 1.5%. Fifth Third trades at a respective 12x and 9.1x past and forward earnings. To put this in greater context, consider that Fifth Third is valued at only 39% of its 3 Digit MG Group PE multiple, while Wells Fargo is valued at only 59% of its historical 5-year average PE multiple. With betas greater than 1, the technical factors are thus pointing solidly upwards.

At its fourth-quarter earnings call, Fifth Third's management, however, addressed weak performance:

"Fifth Third reported fourth quarter net income to common shareholders of $305 million and earnings per diluted common share of $0.33. Earnings results included the impact of charges related to the Visa total return swap and our bankcard association membership, which Dan will discuss in more detail. Those charges were $68 million pretax or about $0.045 per share. Returns remain solid despite the impact of these charges and the initial impact of new debit interchange rules.

Return on assets for the quarter was 1.1%, and return on tangible common equity was 12%. Additionally, tangible book value per share of $11.25 increased 2% sequentially and 13% from a year ago. We posted very strong loan growth for the quarter, with end-of-period portfolio loans and leases up 2% sequentially and up 9% on an annualized basis. We're seeing continued growth in our C&I, mortgage and auto portfolios".

Fifth Third's EPS of $0.30 was 14.3% below consensus. Distressing as this is, the company still is likely to gain market share in mortgage banking, and improve net interest income given the strong momentum in deposits. During the fourth quarter, net interest income increased 2% sequentially, and management guided for upwards of a $20M sequential increase going forward. Mortgage originations further soared $2.6B off the preceding quarter.

Consensus estimates for Fifth Third's EPS forecast that it will grow by 18.5% to $1.41 in 2012, and then by 7.1% to 15.2% in the following two years. Assuming a multiple of 12x and a conservative 2013 EPS of $1.45, the rough intrinsic value of the stock is $17.40, implying 26.1% upside.

Wells Fargo, in my view, has even greater upside. Its excellent liquidity renders the firm capable of boosting capital allocation policy as competitors work on meeting regulatory hurdles. Investors should expect a mid-2012 inflection point stemming from approval for greater share repurchases and dividend distributions.

I am further attracted to how the company dramatically increased scale from the acquisition of Wachovia, which now makes it one of the top four banks - a transformation that will not fully be appreciated until a full recovery. Around one-third of deposits are now estimated to come from markets where Wells Fargo ranks #1 in share. Over the last decade, Wells Fargo has only funded assets at an average cost of 1.4%, 20% less than its main rival.

Consensus estimates for Wells Fargo's EPS forecast that it will grow by 13.1% to $3.19 in 2012, and then by 13.2% and 15% in the following two years. Assuming a multiple of 12x and a conservative 2013 EPS of $3.56, the rough intrinsic value of the stock is $42.72, implying 37.4% upside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.