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|Subject: Wells Fargo (WFC)||Date: 5/23/2013 3:44 PM|
|Author: kelbon||Number: 137 of 592|
Pitch a bank for the portfolio[…]
The most obvious candidate is Wells Fargo (WFC)
In 2008 Wells Fargo doubled its size with the purchase of Wachovia, which makes it one of the four largest banks in the U.S. However, amongst its peers its business model is the simplest.
More than one third of the bank's deposits come from markets where Wells Fargo is top dog, with more than two-thirds coming from markets where WFC is in the top three. Consequently, customers can conveniently find branches and cash machines everywhere.
Once this bank snags a new customer their hope, and strategy, is to cross-sell them other services, snaring them further. Got your checking account at Wells? Why not your mortgage? We have brokerage services and how about a business loan too? This successful strategy deepens its customer relationships and makes it harder for them to jump ship due to switching costs and the inconvenience involved. In other words it gives the bank pricing power. This, and geographic spread and penetration, results is one trillion in low-cost deposit funding, which is around 70% of Well's funding.
Well's was able to fund its assets at an average cost of 1.3% over the last decade, about 20% cheaper than its closest competitor. It's this low cost of funds that has allowed the bank to be more risk adverse than some of its competitors. The company has embarked on an expense-reduction program, which if successful, combined with it's low funding costs, will provide a significant tailwind.
Wells Fargo is not a big derivatives dealer. This activity is only a fraction of J.P. Morgan Chase's. This lessens the likelihood of rogue trading and the consequences of any regulatory changes.
Although their deposit base is substantial they are not overly reliant on net interest income. Non-interest income is nearly 50% of revenues which includes investment related fees and commissions and mortgages. WFC now controls about one third of the country's mortgage market, which of course involves some cleanup due to "missteps" during the housing bubble. All the same, Wells Fargo was not the most aggressive mortgage originator during the bubble so mortgage expenses should be manageable.
Wells Fargo is now in the position to return more capital to shareholders via increased dividends and share buybacks. The bank should be in a good position to increase the dividend going forward and meet its goal of eventually returning 50%—65% of its growing earnings to shareholders.
For what it is worth Morningstar considers WFC's stock slightly undervalued; they peg its fair value $43 a share. And, they give them a credit rating of A+.
One the subject of valuation, WFC's P/E is about 10.5 (Value Line) which is on the lower side historically. VL expects an earning's CAGR of 8% over the next 3-5 years and dividend increases to be north of that (well above the rate of inflation) The current payout ratio is conservative at about 31%. Guessing at stock price they expect it to be between $50 and $75 for 2016-18 (based on a P/E of 14). Value Line ranks WFC 3 for Safety (1 is highest). The Safety ranking was downgraded in March '09. As for Financial Strength they give an A (A++ is highest).
As for Value Line's opinion:
Wells Fargo is one of the strongest and best-capitalized operators in the banking industry. After undergoing a battery of Federal Reserve "stress tests", the company recently received approval to raise the quarterly dividend 20% a share for an annualized rate of $1.20. Although the stock is ranked to mirror the broader market in the year ahead, it has above-average total return potential to 2016-18.
Berkshire Hathaway (Warren Buffett) can't get enough of this stock, to the point that it is now Berkshire's largest individual stock holding. They were still buying at stock prices not far south of today's. If Buffett is wrong about Wells Fargo his legacy as a great and storied investor will be in jeopardy, as will Berkshire Hathaway's stock price. There's no doubt he believes Wells to be an exceptional business and investment.
From various sources, and in his own words, Buffett on banks and Wells Fargo:
"I do not worry about the banking system being the cause of the next bubble. In the end it will be something else," Buffett said. "I feel very good about our investment in Wells Fargo."
"They’ve got a sensational mortgage operation. The total mortgage market was at the $3 trillion level not that long ago. If it goes back up to $3 trillion, I hope Wells is going a third of those."
"Wells did the best job of the big players in the mortgage market and therefore they’ve garnered a share as the other fellows have fallen by the wayside."
"I like Wells Fargo better than anything by far. It complicates life when I and buying things as opposed to the Berkshire Hathaway. I get what is left over…I like Wells Fargo better [than JPMorgan]. We have been buying Wells Fargo month after month for a lot of years. Among the big banks, I think it is the best."
"[…]And Wells ... you can't take away Wells' customer base. It grows quarter by quarter. And what you make money off of is customers. And you make money on customers by having a helluva spread on assets and not doing anything really dumb. And that's what they do."
Relatively simple business model
Expert at cross selling services to customers
Asset costs lowest in the business
Significant branch saturation
Respected and relatively conservative management
Rising dividend (currently 3%)
Buffett has an all-in bet on this bank
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