Wells Fargo turnaround is well underway
"It's tough to make predictions, especially about the future" -Yogi Berra
It has been about a year since we first recommended Wells Fargo as an attractive stock for purchase. Too bad we didn’t know then that we were about to experience a 100-year global pandemic, leading to the worst year for economic growth since World War II. The economy shed more than 20 million jobs in a matter of weeks; and, one year later has only recovered one-half of those lost jobs. Despite all that, Wells Fargo continues to move forward with its turnaround and we think shares remain attractive.
In the immediate aftermath of the COVID-19 pandemic most major banks including Wells Fargo, Citigroup, and JP Morgan suspended their buyback programs. The Federal Reserve also capped the amount of capital banks could direct toward dividends. In recent months these restrictions have loosened, and Wells Fargo is resuming its buyback program. Well Fargo also lowered its quarterly dividend from 51 cents to 10 cents last summer. We think the dividend is likely to increase over the next several quarters. These actions were done in an effort to increase reserves due to higher provisions for loan losses.
Here is what Jim Cramer recently said about the capital return plan at Wells Fargo:
So also with Wells there's an underappreciated capital-return story here. Just real quick: Wells Fargo [authorized] an increase to the repurchase program. They added 500 million shares to it. That brings it to a total of 667 million shares. That's about 16% of the total shares outstanding. That's a huge figure. So Wells Fargo [also] ended the year with $31 billion worth of excess capital on the books. And that just serves as a great reminder of how much capital returns can really be part of the story here as the Fed loosens its grip on the banks.
Wells Fargo CEO Charlie Scharf has remade the executive team with new hires. Scharf’s new executive team is focused on optimizing the business by refocusing their efforts on the core segments and shedding the noncore businesses. Wells Fargo sold its $10 billion student loan portfolio in December 2020 to Firstmark, a division of Nelnet. Wells Fargo is also in the process of selling its $600 billion asset management business, which could fetch more than $3 billion. It also recently sold its Canadian equipment financing business.
Wells Fargo continues to work with regulators to clean up its practices. In January the Office of the Comptroller of the Currency terminated a 2015 consent order. The bank still has several other regulatory matters to resolve and we expect continued progress from the current management team on these matters. The next major regulatory event for Wells Fargo is to get the asset cap removed … someday.
We think Wells Fargo shares could increase 50% or more over the next few years. We anticipate earnings per share to be around $3 in 2021, rising to $5 by 2023. We also expect the bank to gradually increase its quarterly dividend and its share buyback program. Combined, these programs produce a shareholder yield of more than 15%. The biggest risk to the continued recovery is another recession, which could happen if COVID-19 mutates into a vaccine resistant strain. However, the world is now much better prepared to respond to new mutations and the vaccine manufacturers are already preparing to rollout boosters that account for mutations.
Miller Value Partners recently wrote the following about Wells Fargo in their quarterly investor letter, which we wholeheartedly agree with:
Over the past couple of months, we increased the weight in the Financial sector. As we highlighted earlier, we believe the recent underperformance by the largest Banks provides a very attractive reward/risk opportunity for long-term investors and should significantly outperform the market over the next couple of years. During the second half of the year, we initiated a position in Wells Fargo (WFC). The company’s share price has been under significant pressure since the 2016 account scandal, leading to senior management resignations, significant incremental expenses, and regulatory oversight. The company has a new CEO, Charlie Scharf, who joined in 2019 from JP Morgan. Charlie has been moving quickly to turnaround the company. He has brought in six new members to the Operating Committee all from outside the company and has recruited numerous successful senior executives from JP Morgan, BNY Mellon, and other leading financial institutions to fill senior roles at the bank. The company is taking a fresh look at each business segment, benchmarking against its peers. The company’s operating efficiency is more than 1700bps out of line with their peer group, providing a $10B cost and efficiency opportunity over the next couple of years. Wells Fargo’s stock price was more than cut in half during 2020; we entered the position at a 40% discount to book value which was near 30 year lows and approaching 2008-09 Financial crisis levels. Over the next couple of years, greater operating efficiencies and loan growth would support a return to 10%+ ROE, normalized EPS of $5/share, and book value likely approaching $50/share. We believe it’s more likely than not Wells Fargo’s share will be a top performer over the next couple of years.
In retrospect, we wish we had waited one more month before we published our Wells Fargo recommendation last year. However, we still think the turnaround at Wells Fargo is likely to succeed, and we think long-term investors will be rewarded for their patience.