U.S. Bancorp: Reduce Long Exposure

| About: U.S. Bancorp (USB)
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U.S. Bancorp (NYSE:USB) recently released third quarter earnings. The firm's financial performance and position continue to be attractive to investors. We'll cover the financial performance and position, take a look at the Greece situation, third quarter earnings, and update the recommendation for U.S. Bancorp.

Financial Performance and Position

U.S. Bancorp's interest income grew four percent in 2011 compared to 2010. Interest income is at a four-year high. Net income at the end of 2011 was at a four-year high. Cash flow from operations increased almost 50 percent between 2010 and 2011. Total equity is increasing as the cash balance grows.

Interest income this year is on pace to increase compared to 2011. Interest income was flat in the third quarter compared to the second quarter. Interest income is reported as $3.23 billion in the third quarter. Compared to the year-ago quarter interest income increased from $3.2 billion to $3.23 billion.

Net income this year is on pace to increase compared to last year. Net income of $1.47 billion reported in the third quarter was higher than the $1.42 billion reported in the second quarter. In the year-ago quarter net income was $1.27 billion.

Interest income growth and net income growth are positive signs for investors. Interest expense is declining, and the provision for credit losses is trending lower. Also, non-interest expense is trending higher.

U.S. Bancorp is one of the most profitable financial firms with a profit margin of 44 percent through the first nine months of the year. In comparison, Goldman Sachs (NYSE:GS) had a profit margin of 15 percent, and Citigroup (NYSE:C) had a profit margin of 12 percent.

The financial leverage ratio remained the same: equity is 11 percent of total assets. Return on equity increased to 3.9 percent in the quarter from 3.8 percent the previous quarter. Management was more effective at generating return on invested equity.


The financial performance has been splendid. The firm is growing revenue at a time when a lot of financial firms are seeing revenue decline. With that factored in, I consider U.S. Bancorp to be fairly valued to undervalued. I used a present value dividend discount model to estimate the intrinsic value as somewhere between $35 and $44-share. If the share price declined 10 to 20 percent, I would consider purchasing shares depending on other value relevant factors.

The price-sales multiplier model valuation metric is off of its high, however, the firm is still overvalued on a short-term basis.

The valuation models suggests different investment stances. That said, given the financial strength of the firm, I would recommend investors continue to stay long and add to positions on throwbacks. Some long equity risk may be taken off of the table as markets may be due to correct.

Greece and ECB

Following a study showing fiscal cuts may have bigger effects on economies than previously estimated, IMF Managing Director Christine Lagarde endorsed the idea that Greece be given an extra two years to meet its goals and raised the idea of another round of debt restructuring before further bailout efforts can proceed.

Personally, I figured an extension of the deadline to meet the goals and another debt restructuring were foregone conclusions after the initial Greek debt restructuring. That said, market participants may consider the restructuring to be an event with an uncertain outcome and may view it as an appropriate time to reduce risk.

Germany's Schaeuble, said government's can't accept losses on Greek debt holdings. Schaeuble didn't say that private creditors can't or won't accept losses on Greek debt holdings.

ECB officials are resisting calls to cut interest rates, saying doing so would have little effect and there are no deflation risks. I disagree, cutting the benchmark rate to 0 percent and introducing a round of quantitative easing will have a substantial impact. That said, it seems as though the catalyst for ECB action is signs of deflation.

Third Quarter Earnings

Of the 48 companies that have reported since Oct. 9, 35 posted earnings that exceeded analyst estimates.

Thus far the earnings numbers have been good. Bulls are hoping the numbers continue to be good. The impact of QE3 should begin to show in the Q4 2012 or Q1 2013 data.


U.S. Bancorp continues to be a standout among financial firms. That said, the valuation is short-term extended. I wouldn't put new money to work at these levels. It may be wise to reduce long-equity exposure.

We have more clarity on what it would take for the ECB to reduce the benchmark rate and stem the sovereign debt crisis in Europe.

Third quarter earnings have been good thus far, however, several companies haven't reported and we'll need to see results from more firms before reaching a conclusion about the third quarter.

Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.

Disclosure: I am short SPY. 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.