Wells Fargo (NYSE:WFC) has pronouncedly underperformed the market this year. To be sure, the stock has lost 10% while S&P (NYSEARCA:SPY) has gained 2%. The underperformance is merely the result of a wide range of negative headlines that are specific for the financial sector and the company, such as the slower pace of interest rate hikes, major losses due to the collapse of the oil price, new constraints due to the "too big to fail" designation and the downgrades from some analysts. However, the earnings report that was released yesterday indicates that these concerns are clearly overblown.
First of all, despite the concerns over slower interest rate hikes, the net interest income of Wells Fargo increased 6% in Q1 over last year thanks to the hike of interest rates implemented in Q1. The net interest income was also helped by the growth in earnings assets thanks to the addition of the assets of General Electric Capital and the disciplined deposit pricing of the company. While the Fed will raise the rates more slowly than initially expected, the trend of higher rates will still provide a meaningful boost to the results of Wells Fargo.
Investors should also realize that the concerns over the exposure of the company to the collapse of the oil price are overblown. To be sure, while the total exposure to the oil sector is $40.7 B, only 45% of this amount is exposed to the extraction sector, which is the sector under the greatest pressure. Refiners, which are responsible for 8% of the exposure of the bank, are really thriving right now. Therefore, the total exposure to the extraction sector is about $18 B. Even if 1/3 of these loans is written off (an imaginary scenario), Wells Fargo will lose one quarter's earnings, i.e., certainly a manageable result for an imaginary worst-case scenario.
Investors should also not underestimate the prudent management of Wells Fargo, which provides the stock with a safety net from all the potential headwinds mentioned in the introduction. In addition, the stock is reasonably valued right now, with a forward P/E=12, price/book=1.45 and expected growth of earnings per share [EPS] 8% for 2017. Therefore, as the interest rates will gradually rise, even at a slower pace than initially expected, the net interest income of the company will grow and its EPS will follow. Even better, when the market realizes that the above concerns are overblown, it will probably reward the stock with a higher P/E. Therefore, the stock is likely to receive a double gift; higher EPS and a higher P/E.
There is only one caveat on the earnings report. The company repurchased 51.7 M shares or 1% of its outstanding shares in Q1. However, it retired only about 1/3 of those shares, while it distributed the other 2/3 to its managers as a bonus. In other words, the management rewarded itself with about $1.7 B in Q1 or 1/3 of its earnings. This is clearly detrimental for the shareholders and is not a proper way to use the funds of the company even during the most prosperous times, let alone the current period. The management should definitely stop rewarding itself so excessively and use the profits in a much more productive way to enhance shareholder value.
Nevertheless, the earnings report of Wells Fargo proved that the extremely negative recent headlines for the company are at least exaggerating. The company is expected to maintain flat earnings this year and grow 8% next year thanks to the upcoming hikes of interest rates. Investors just need to be patient for the dust from the headlines to settle until the fundamentals take over.
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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.