Is Wells Fargo Stock Undervalued?
Wells Fargo stock (NYSE: WFC) lost more than 53% – dropping from $54 at the end of 2019 to around $25 in late March – which is also the current level.
This can be attributed to two factors: The Covid-19 outbreak and economic slowdown meant that market expectations for 2020 and the near-term consumer demand plummeted. This could negatively affect businesses and individuals, impacting their loan repayment capability and exposing Wells Fargo to sizable loan losses. While the multi-billion-dollar Fed stimulus provided a floor and several of Wells Fargo’s peers benefited from it, the same was not true for the bank due to a relatively smaller presence in sales & trading and investment banking businesses.
However, we think investors remain over-cautious about Wells Fargo’s stock
Trefis estimates Wells Fargo’s valuation to be around $31 per share – about 15% above the current market price – based on an upcoming trigger explained below and one risk factor.Recommended For You
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The trigger is an improved trajectory for Wells Fargo’s revenues over the second half of the year. We expect the company to report $73.2 billion in revenues for 2020 – around 14% lower than the figure for 2019. Our forecast stems from our belief that the economy is likely to open up in Q3. The easing of lockdown restrictions in most of the world is likely to help consumer demand, resulting in higher business spending. Wells Fargo has a relatively smaller presence in investment banking and the Sales & Trading space as compared to its peers. As a result, it has not benefitted from a jump in trading volumes in the securities market and higher underwriting deals after the Fed stimulus. Overall, we see the company reporting an EPS of around $0.74 for FY2020.
Thereafter, Wells Fargo’s revenues are expected to improve to $74.4 billion in FY2021, mainly due to improvement in consumer banking and commercial lending revenues. Further, the net income margin is likely to improve as compared to the previous year due to a decline in provisions for credit losses, leading to an EPS of $2.63 for FY2021.
Finally, how much should the market pay per dollar of Wells Fargo’s earnings? Well, to earn close to $2.63 per year from a bank, you’d have to deposit about $285 in a savings account today, so around 110x the desired earnings. At Wells Fargo’s current share price of roughly $25, we are talking about a P/E multiple of just below 10x. And we think a figure closer to 12x will be appropriate.
That said, Banking is a risky business right now. Growth looks less promising, and near-term prospects are less than rosy. What’s behind that?
Wells Fargo originates and services the largest number of mortgages in the USA. Further, it has a huge portfolio of consumer, commercial, and wealth management loans – around $932 billion in FY2019 with roughly $320 billion in outstanding mortgages. The economic downturn could negatively affect the loan repayment capability of its consumers, exposing the bank to significant loan defaults. As a result of this exposure, the bank has increased its provisions for loan losses to around $13.5 billion by Q2 2020– roughly 10x of the year-ago period, leading to a huge spike in total expenses for the year. If the economic condition worsens, this figure could further increase in the subsequent months. Additionally, a negative economic outlook will make it expensive for the bank to attract funding, increasing the cost of its operations.
The same trend is visible across Wells Fargo’s peer – Bank of America. Its core banking revenues are likely to suffer in FY2020 due to a lower interest rate environment. Further, its margins are likely to drop due to build-up in provisions for credit losses in anticipation of bad loans. However, unlike Wells Fargo, positive growth in its trading arm and investment banking business in FY2020 would more than offset the weak core banking revenues. This would explain why Bank of America’s stock currently has a stock price of over $24 but looks slated for an EPS of around $2.43 in FY2021 (for a P/E multiple of nearly 12x).
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Led by MIT engineers and Wall Street analysts, Trefis (through its dashboards platform dashboards.trefis.com) helps you understand how a company’s products, that you… Read More