Coronavirus Beaten Down Stocks/Funds Series – Wells Fargo & Company

This post was originally published on this site

This article first appeared on Trend Investing on April 22, 2020; therefore, all data is as of this date.

In this ‘coronavirus beaten down stocks/funds’ series of articles, I look at both stocks and funds that have been beaten down due to the COVID-19 (coronavirus) market sell-off and are near or below their 5-year low, are very well valued, and have potential to rebound strongly as we recover.

Today, I look at Wells Fargo & Company (NYSE:WFC), which is one of the largest US retail banks. The stock has been heavily sold down 50% YTD in 2020. The past few years WFC has come under larger regulatory scrutiny following the Wells Fargo fake bank accounts scandal which resulted in a US$3b settlement payment by the bank.

The recent coronavirus impact has so far caused the bank to add a $3.1b reserve (impairment) charge and a $950m impairment of securities. This led to a Q1 EPS of just 1 cent. Clearly, 2020 will be a low point for earnings, with recovery expected in 2021.

Wells Fargo & Co.

Source

Wells Fargo & Co. – Price = $26.84

As shown on the chart below, WFC has fallen from a high of $65.93 in 2017 to a recent low of $26.23, and has recently recovered slightly back to $26.84, which is 59% below the past peak and an 8-year low.

Wells Fargo & Co. – 5-year price chart

Wells Fargo & Co - 5 year price chart

Source: Bloomberg

WFC – 30-year performance chart

Looking at the 30-year chart below, WFC is back to its price from 2012, which is 8 years ago.

Source: Yahoo Finance

A look at Wells Fargo & Co.

WFC is one of the top 5 US retail banks.

Wikipedia summarizes well:

Wells Fargo & Company is an American multinational financial services company headquartered in San Francisco, California, with central offices throughout the United States. It is the world’s fourth-largest bank by market capitalization and the fourth largest bank in the US by total assets. Wells Fargo is ranked number 26 on the 2018 Fortune 500 rankings of the largest US corporations by total revenue. In July 2015, Wells Fargo became the world’s largest bank by market capitalization, edging past ICBC, before slipping behind JPMorgan Chase in September 2016, in the wake of a scandal involving the creation of over 2 million fake bank accounts and illegal manipulation of other accounts by Wells Fargo employees. Wells Fargo fell behind Bank of America to third by bank deposits in 2017 and behind Citigroup to fourth by total assets in 2018.

A comparison between the major banks shown below shows Wells Fargo has the largest home mortgage book and is also the largest in commercial real estate loans.

A 2018 comparison of the major US banks loan books

WFC new CEO Charles Scharf

Wells Fargo CEO Scharf shakes up management at scandal-hit bank ...

Source

Wells Fargo Q1 2020 results

As shown below, WFC Q1 2020 results were marred by a COVID-19 led slowdown and their large write-downs (impairment charges) for future bad loans. Their net interest margins remains solid at 2.58%.

As reported by Seeking Alpha:

  • Q1 Revenue of $17.72B (-18.0% Y/Y).
  • Q1 Non-GAAP EPS of $0.80 beats by $0.18; GAAP EPS of $0.01 (due to the large write down – a $3.1B reserve (impairments charge) and a $950M impairment of securities.
  • “Q1 net interest income (FTE basis) of $11.3B vs. Visible Alpha consensus of $11.2B and $11.2B in Q4 2019; net interest margin of 2.58% vs. 2.54% consensus.
  • Q1 provision for credit losses for loans were $3.83B, as the bank prepares for expected credit deterioration due to the COVID-19 impact.
  • Q1 net loan charge-offs of 0.38% (annualized) rose from 0.32% in Q4 2019 and 0.30% in Q1 2019.

Q1 segment net income:

  • Community Banking segment net income of $155M, down 64% vs. Q4 2019 and down 95% Y/Y; provision for credit losses increased $1.2B Q/Q and $1.0B Y/Y due to reserve build reflecting expected credit deterioration due to the COVID-19 pandemic.
  • Wholesale Banking segment net income of $311B, down 88% Q/Q and 89% Y/Y; provision of credit losses increased $2.2B Q/Q and Y/Y on expected effect of COVID-19.
  • Wealth and Investment Management segment net income of $463M rose 82% Q/Q and 20% Y/Y; total AUM of $518B rose 9% Y/Y.
  • Q1 trading-related revenue of $838M fell 15% Q/Q and 27% Y/Y.”

Given the US is still battling with coronavirus, Q2 will also be tough for WFC, and will depend on the rate of reopening of the US economy.

Low interest rates in USA

The US Federal Reserve recently lowered rates to a record low of just 0.25%. The implication here for all the banks is that in a very low interest rate environment it is harder for banks to justify and make a decent ‘net interest margin’ (the margin it makes between deposit funds and lending funds). This would mean there is pressure on WFC net interest margins in 2020.

The coronavirus impact on WFC and the US rescue package

WFC’s response to COVID-19 is summarized by the bank’s statement:

We’re suspending residential property foreclosure sales, evictions, and involuntary automobile repossessions. Also, on a case-by-case basis, we’re offering fee waivers, payment deferrals, and other expanded assistance for credit card, auto, mortgage, small business, and personal lending customers who contact us.

The US government’s response has included:

  • A US$2 trillion coronavirus emergency cash bill. The package includes money to help recently unemployed Americans pay bills, gives emergency loans to small businesses, and increases funding for hospitals, health systems and other health care needs… and a US$500 billion fund to help hard-hit industries with loans, and another fund to provide direct payments of up to US$3,000 to millions of US families.
  • The bill will give all unemployed Americans US$600 a week extra (for 4 months) on top of the existing unemployment benefit of ~US$385 a week.

US coronavirus update

The US is the most affected country in the world with coronavirus cases. As of April 21, 2020, the US had 819,164 cases and 45,340 deaths. As shown below, daily new cases have stabilized and are perhaps heading down.

US new daily coronavirus cases as of April 21, 2020

Source: Worldometers.info

Valuation

WFC has a current market cap of $110B. The 2020 PE ratio is 22.3, and the 2021 PE is 9.7. 2020 net profit margin is expected to take a COVID-19 hit and fall to an estimated 8.29%, recovering in 2021 to reach a more normal 15.67%. This is already discounted into the stock price.

The 2020 dividend yield is forecast at 7.62%, and 2021 dividend yield is forecast at 7.72%. The 2020 dividend may be cut or reduced due to the 2020 earnings hit from COVID-19.

The 2020 Price to Book ratio is only 0.67x, or 0.66x for 2021.

4-traders’ analyst consensus is a ‘hold’ with a price target of $32.37, representing ~21% upside. Yahoo Finance shows a price target of $32.90.

My view is that the stock has been oversold and is now very cheap based on the 2021 low PE of just 9.7 (yield 7.72%), assuming a COVID-19 recovery occurs at some stage in 2020.

WFC financial summary and forecasts

Source: 4-traders

Risks

  • The COVID-19 pandemic may cause a longer disruption (>1 year), and hence, the US consumer may struggle to meet their mortgage payments, especially if unemployment levels remain high. US government consumer support and banks flexibility should help.
  • Low interest rates may remain for several years, making it hard for banks to improve margins.
  • US has quite moderate household debt to GDP levels (~75%) and moderate house prices depending on the location.
  • Competition. New 100% digital banks (‘neobanks’) with no office presence can offer lower cost products.
  • Reputation, regulation and litigation risk – The past few years has seen greater scrutiny on WFC, especially after their fake bank accounts scandal. The new CEO will be highly motivated to keep WFC clean.
  • Currency risk and management risk.
  • The usual stock market risks. Market sentiment – COVID-19 (coronavirus) has been causing global lockdowns and economic disruption, which in turn has lowered investor sentiment.

Further reading

Conclusion

WFC’s stock price has fallen 50% in 2020, back to 2012 levels. 2020 will see significantly lower earnings, which is already priced into the stock, assuming we get a 2020 COVID-19 recovery.

Once we recover from COVID-19, the bank should continue to do well and earnings should recover. Analysts’ forecasts (assuming a recovery) have WFC on a very cheap 2021 PE of 9.7, dividend yield of 7.72%, and P/B ratio of a mere 0.66x. My view is the bank is now oversold and undervalued, assuming we are back to a near normal earnings environment by 2021.

Risks revolve around the length of the COVID-19 pandemic, and how long the government will backstop the economy. US unemployment is also a current concern. Smaller risks include competition, including competition from lower costs lenders and the new digital banks.

I rate Wells Fargo as a strong recovery ‘buy’ for those investors with a 5-year plus time frame.

As usual, all comments are welcome.

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 in this article is general in nature and should not be relied upon as personal financial advice.

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