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JD, CPA, 18 years CEO/CFO, investor for 50 years
  • Wells Fargo Comparison Of 2003 With 2011 (and Profit & Stock Price Projection) 4 comments
    Feb 13, 2012 2:09 PM | about stocks: WFC

    2003 was fairly typical of the period of 2001-2006 in terms of the first 5 years of the millennium relative to the general economy as well as Wells in terms of its performance and stock price matrix. (Info derived from Morningstar) In other words, 2003 is pretty representative of what we can expect over time and I'm too lazy to do a year by year analysis.

    My point in this article is....Wells stock should revert to its 2003 relationship to its ratios described here and its income should vastly improve...yielding a $90 price in 3-4 years.

    2003 is representative of the years 2001-2006 and is indicative of "normal" for WFC (IMHO)

    .......................12/31/03....... 12/31/11

    Stock price

    (2/4/03 and now) $29............... $30.6

    Book Value/share.$10.90...........$24.40

    Sh price/book..... 2.66............... 1.25

    Shares out..........3.4 Bil............. 5.3 bil.

    12 mos net inc.. $6.2 Bil............ $15.9 Bi.

    Sales/Share...... $8.35.............. $15.50

    Earnings/sh....... $1.83...............$2.82

    Deposits/sh....... $72.65.............$160

    Loans/sh........... $75.................$153

    Net Int Mrg(NYSE:NIM) 5.08%..............3.89%

    Total Assets/Sh ..$114............... $237

    Credit loss/rev..... 6.1%.............. 10.0%

    Credit Loss/Loans .6%................. 1%

    Non-int exp/ revs 60.6%............. 61.4%

    Return on Assets 1.68%............. 1.14%

    Equity/assets...... 10% ...............10%

    Return on Equity 19.21%............ 11.92%

    P/E...................15.8................ 10.85

    Stock yield %..... 6.3%................ 9.2%

    10 Yr. Treas Yld.. 4.2%............... 1.9%

    Analysis

    I believe 4 things will drive Wells stock going forward:

    1. The low yield on bonds will force investors to go elsewhere. The general P/E of the S&P 500 for 2012 is expected to be 12, yielding 8.33% or 4+ times the 10 year Treasury. People are going to be forced to use principal to live on, pensions that assume 7.5% yield are going to need returns…There are no loans to buy real estate on needed leverage…stocks are it for yield…risk be damned.

    2. The financials will be less disfavored in 2012 (they already are). However, in general, skeptical investors will not expand the stock prices of banks to historical P/E ratios. However, this will be largely offset by lower alternative yields on fixed income bets, including Treasuries, so I think P/E's will get back to where they were in 2003.

    3. Investors will once again "trust" WFC and JPM, neither of which has deserved the trashing they have taken. Wells in particular will be seen as an undeserved victim of the trashing…it's a real bank that makes money the way George Bailey does…Midwest, take deposits, make loans and provide excellent service….the old fashioned way. (Forbes…here we come!)

    4. Wells earnings are going to vastly improve over the next year.

    Summary: Wells will attain a forward P/E of 15 13-15 times in a year…probably the end of 3Q as opposed to a forward P/E of 8.7 now. Projected 12 mos. forward earnings will go from $3.20 (now) to $4.50+ by 4Q 2012, if not much earlier.

    Is Wells Stock Cheap Now?

    If you look at the first 8 data points listed above and the last 3 data points assuming that 2003 is typical for Wells and the stock is "CHEAP" The analytical factors 1-3 articulate my premises that the stock will go up a bunch in 2012, closer to normal ratios. It's going to take positive revenue and earnings trends as well to drive the stock to historically normal pricing. However, the growth of earnings will have the double effect of not only affecting a normal P/E, but the denominator ("E") is really going to kick the stock as it goes up much faster than current expectations.

    What is Going to Cause Earnings Gains?

    Macro Economic:

    Timing of this is difficult to predict. In fact, I'm already wrong by a year. We've now had 3 years of economic malaise, overlaid by Obama, bank bashing, bank litigation, interest rate spread compression and about everything else that makes the banking environment horrible.

    I believe that the additional year of bad times has more tightly wound the spring for growth when it happens (I hope now). In particular, housing, jobs,, capital equipment and cars are spring loaded for growth. When this happens, loans will be made, interest rates will go up and banks will click considerably better than historically, as measured by 2003.

    The following will directly benefit from the macro changes as well:

    · Net interest margin will go back to 40 basis points less than the 2003 level of 5.08%. Assuming no deposit growth, pre-tax income would increase by $10 billion annually with this recovery.

    · Bad debts will revert to the 2003 rate of .6% from the 2011 rate of 1% of revenues…about $350 million/year.

    · If Wells can make record profits in 2010 and 2011, just think what will happen if the economy even normalizes, let alone springs back. Wells has performed in spite of the economy…turn that headwind into a tailwind for a couple of years and I believe Wells gets at minimum a $10 billion/year pre-tax swing.

    Wells Specific Profit Drivers:

    Expenses:

    · … are much too high. Wells has announced that it will reduce operating expenses by $1.5 billion/Q by 4Q of 2012, with substantial improvement by 2Q. In 2011 operating expenses were 61.4% of revenues compared to 60.6% in 2003.

    · The completion of the Wachovia integration drops $500 million/Q of expenses, so where does the rest come from? I believe Wells is blowing at least $1.5 billion a Q on the housing mess. It lost $404 million alone on Fannie Freddie mortgage warranties last Q, with like amounts before. The wind down of foreclosures, refinances and litigation has got to further enhance this savings. Wells has about 30,000 extra employees handling this, let alone lawyers, lobbyists and outside contractors.

    · Wells has completed a single computer platform to run its entire business, down from 100+ a couple of years ago. Not only is this going to halt the conversion costs, but what about the efficiency going forward…another tailwind replaces a severe headwind?

    · Technology and size of the enterprise should vastly lower expenses relative to revenues. Think about 14,000 envelope-free ATMs compared to what was available in 2003. Overlay going from 100 computer platforms to manage them (along with 45 million accounts) to 1 in the last 2 years?

    · How much money is being saved thru Wells best-in-class internet banking offering (also now on one platform)?

    · How much money is being saved by rolling up to a single bank with $1.3 Trillion in assets in terms of highly paid duplicative management? We're talking about 1 CEO, etc. here.

    Conclusion: Wells expense savings projection of $1.5 billion/Q seems quite conservative.

    Buffett said a couple of years ago that Wells is quite capable of a PTPP (pre-tax, pre-provision) profit of $40+ billion in normal times. If one overlays Wells announced expense reductions of $1.5 billion/Q with the current PTPP of $8.1 billion, it is almost there. Throw in the macro-economic factors plus Wells's market share gains and we're talking of a PTPP of $50 billion + annually. Deduct say .7% of credit losses and pre-tax income hits $44 billion +.

    After tax, $28.5 billion or $5.65/share? A 16 P/E? ….a $90+ stock price?

    Disclosure: I am long WFC.

    Stocks: WFC
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