Wells Fargo: The Bull And Bear Thesis - Part 2: A Buying Opportunity?

| About: Wells Fargo (WFC)

Summary

Investors wonder if the timing is right to become more constructive on Wells Fargo.

In our prior article we laid out the bear thesis on WFC.

In this article we discuss the bull arguments on the stock.

In our prior article we laid out the bear thesis for Wells Fargo (NYSE:WFC).

In this article we discuss the bull arguments, illustrating that WFC currently offers a very attractive buying opportunity.

#1: Valuation appeals here

Wells' valuation is attractive and the stock is rarely this inexpensive. WFC is trading at 11.2x forward earnings and at 11.8x if we cut its EPS by 5%. The 11.8x multiple is still below the 3-year average and just a tad higher than the 5-year average. This also compares to 13.0x the average of other high-RoE U.S. banks: BB&T (NYSE:BBT), M&T (NYSE:MTB), PNC (NYSE:PNC) and U.S. Bancorp (NYSE:USB)

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Source: Bloomberg

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Source: Bloomberg

Wells also looks attractive on a P/B - RoE basis. The stock is trading below the sector's regression line, despite its best-in-class dividend yield.

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Source: Bloomberg, Renaissance Research

#2: The event will not have a lasting impact on WFC's valuation

In our prior article we noted that there have already been several cases where large-cap U.S. banks were negatively affected by an unexpected material event. While the banks affected by these events have underperformed the sector in the 1-3 month period, they have each regained their multiples within the 9-12 month period. In other words, these issues have not had a lasting impact on the banks' valuation metrics. As such, one can argue that Wells will likely regain its premium multiples over the next 9-12 months.

#3: The underperformance has probably peaked

In the cases mentioned above, underperformance peaked at 20% for JPMorgan (NYSE:JPM), at 15% for Goldman Sachs (NYSE:GS) and at 10% for Bank of America (NYSE:BAC). Wells Fargo has underperformed the KBW Bank index (BKX) by 10% since the announcement of the settlement. We also note that this 10% underperformance is in addition to the 7% underperformance in 2016 pre-announcement. As such, it is possible that Wells is close to peak underperformance.

#4: Best-in-class dividend yield

The stock's underperformance has driven WFC's dividend yield to 3.4%.

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Source: Bloomberg

As the table below shows, this is the highest dividend yield in the peer group.

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Source: Bloomberg, Renaissance Research

This suggests to us that WFC offers a very attractive dividend yield at low multiples.

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Source: Morgan Stanley Investment Research

The chart below shows that Wells' dividend yield has reached a new post-crisis high.

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Source: Bloomberg

WFC's dividend yield also looks attractive versus the sector and the S&P500.

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Source: Bloomberg

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Source: Bloomberg

#5 The dividend is safe

We do not think that dividends are at risk. Wells paid $185mn to settle the case. The penalty represents less than 1% of WFC's 2016E earnings and, as such, it had no material impact on Wells' bottom line.

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Source: Bloomberg

A "conditional pass" under the 2017 CCAR has a very low probability, in our view. Moreover, even in the event of a conditional pass, the Fed has allowed banks to provisionally go ahead with their capital deployment plans.

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Disclosure: I am/we are long JPM.

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.