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Wells Fargo: A New Day With A Still Strong 14% Yield

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About: Wells Fargo & Company (WFC)
by: Stone Fox Capital
Stone Fox Capital
Long/short equity, growth at reasonable price, research analyst, Deep Value
Summary

Wells Fargo hit YTD highs after a quarter with disappointing headline numbers.

The solid loans and deposit growth was a strong indication that customers are letting the bank out of the penalty box.

The bank has substantial EPS growth potential from improving the efficiency ratio.

The stock continues to offer a 14% net payout yield due to substantial share buybacks and a 4% dividend yield.

As the calendar recently turned to November, Wells Fargo (NYSE:WFC) finally has an external CEO in charge of the large bank. The Q3 results weren't anything special due to confusing charges and balance sheet repricing, but the large financial is finally positioned for growth while the net payout yield remains an incredible 14%. My investment thesis remains bullish as the stock looks prepared to hit new 52-week highs.

Image Source: Wells Fargo website

Confusing Q3

With a new CEO starting about a week after the quarterly report, the market shouldn't be surprised that Wells Fargo had a quarter fraught with apparent one-time charges. The market generally offset the $1.9 billion losses from litigation accruals and the $1.1 billion gain from selling the IRT business to net out to a $0.15 loss. Analysts added this loss back to the $0.92 EPS to generate an adjusted EPS of $1.07.

Source: Wells Fargo Q3'19 presentation

Despite what still appears to be a $0.10 miss, the stock is up at highs for the year. A lot of the issue was weakness in NIM due to balance sheet repricings from the low interest rate environment.

The quarterly report showed improving trend in loans and deposits. After a period of struggling to grow, Wells Fargo saw period-end loans grow $12.6 billion over last Q3. The loan balance topped the recent peak level back in Q4 with $954.9 billion loans.

Source: Wells Fargo Q3'19 presentation

The deposit growth was even more impressive. The large financial ended Q3 with period-end deposits of $1.3 trillion, up $41.9 billion. Wells Fargo saw growth in wholesale banking, corporate treasuries, mortgage escrows and consumer and small business banking deposits. Basically, the customer base appears to have moved beyond the account fraud scandal.

Source: Wells Fargo Q3'19 presentation

The market has long thought the large bank was under an asset cap that prevented loan growth, but CFO John Shrewsberry was clear on the Q3 earnings call that Wells Fargo has plenty of low-income businesses that can be cut to make room for more loan growth.

I mean within the relevant range of expectations of loan and deposit growth, I wouldn't think of the asset cap as being as really coming into play in our forecast horizon, in part, because there are plenty of levers that we can pull that don't have real customer impact in terms of consumers and our business customers, and we've talked about some of those before in terms of some of the institutional deposits that we take or other wholesale funding that we use, and then, there are some assets that don't work that hard for us from a balance sheet perspective.

Investors have wrongly thought for a while now that the asset cap was holding down loan and deposit growth. The real problem was the account fraud story, and the new CEO should help remove the asset cap next year and further push the company towards growth.

Amazing Yield

While investors are waiting on some cleaner financials and even 2020 projections from the new CEO, the market gets to enjoy substantial capital returns each and every quarter from Wells Fargo. For Q3, the large bank returned $9.0 billion to shareholders, up slightly from $8.9 billion last year.

Despite yearly highs in the stock, the dividend yield remains nearly 4%. The net payout yield that combines the dividend yield and the net stock buyback yield remains a lofty 14.3%. Any net payout yield over 10% is generally indicative of strong value in the related equity.

ChartData by YCharts

The bank saw the share count decline 150.4 million shares linked quarter on net share repurchases of $6.8 billion. When the market cap is only $220 billion, $9.0 billion spent on capital returns in the quarter adds up to over a 4% net payout yield in the quarter alone.

These capital returns aren't going to prevent quarter-to-quarter impacts to the business from the low interest rate environment, but Wells Fargo is ultimately better off when the rate environment improves. The combination with lower expenses from improved employee efficiency to match the other banks discussed in my previous article produces a big EPS pop.

Wells Fargo is likely to end 2019 with 4.1 billion shares outstanding. Another 9% share reduction in 2020 will reduce the share count by 369 million shares while an average annual buyback of $23.1 billion repurchases ~440 million shares at the current price. The ending 2021 share count target could dip to 3.3 billion shares taking the average of a 400 million share count reduction each year.

Assuming the large financial is able to cut the efficiency ratio to 55% from the current ratio around 63% leads to a nearly $7 billion reduction in costs on a revenue base in the mid-$80 billion range. The company has a current earnings base of $20 billion that grows to $26 billion after taxes with a market efficiency ratio. The 3.3 billion share count in 2021 leads to an EPS target of far above $7 only a couple years from now.

Takeaway

The key investor takeaway is that Wells Fargo returning to loan and deposit growth before the hiring of a new external CEO suggests customers are finally ready to move on from the accounting scandal. The combination of a cheap stock allowing for substantial stock repurchases and the ability of a new CEO to cut costs leads to a strong upside for earnings and the stock. For this reason, the stock appears poised for a breakout rally to new recent highs.

Disclosure: I am/we are long WFC. 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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.