January 13, 2023

With today’s note, we discuss the earnings report from Wells Fargo & Company (WFC) and provide updates on several recommended stocks.

Next week, none of our companies are scheduled to report earnings. The deluge starts the week of January 23, with General Electric (GE), Xerox Holdings (XRX), Nokia (NOK), Western Digital (WDC) and Dow (Dow) reporting. The following week will see reports from Vodafone (VOD), Polaris Industries (PII), M/I Homes (MHO), Meta Platforms (META) and Janus Henderson Group (JHG).

Earnings updates:

Wells Fargo & Co. (WFC) – Wells Fargo is one of the nation’s largest banks. Under its previously weak leadership, the company never fully recovered from the 2009 financial crisis and its loose compliance culture led to a fake accounts scandal and other reputation-tarnishing problems. Also, like all banks, it is struggling with low interest rates and limited loan growth, although the much-feared pandemic-related loan losses no longer look likely. An additional constraint is a regulator-imposed cap on Wells Fargo’s asset size. Under new CEO Charles Scharf, the bank is aggressively restructuring its operations, cost structure and regulatory compliance.

Wells reported reasonable fourth-quarter results, but progress with its turnaround is slow, leaving investors in a disappointed mood. We remain committed to our Wells Fargo thesis as the company is making progress and the shares are overly discounted.

Revenues of $19.7 billion fell 6% from a year ago and were essentially in line with estimates. Adjusted earnings of $1.46/share rose 17% from a year ago and were 33% above the consensus estimate. Media commentators looked at reported earnings of $0.67/share and compared these to the year-ago reported earnings of $1.38/share, but both numbers were heavily influenced by unusual items. Some reports indicate that adjusted profits were $0.61/share, which would be an earnings miss. We will need to sort through the numbers over the weekend.

While we scrub out the large charge-offs from our analysis of the bank’s underlying earnings, these costs directly reduce the bank’s regulatory capital levels and thus its ability to pay dividends and repurchase shares. And, they also impact the bank’s valuation: we look closely at its share price as a multiple of tangible book value, so the lower the tangible book value the lower the share price upside potential, all else being equal. Currently, the shares trade at 119% of the $34.89/share tangible book value.

In the quarter, loans were up 8% from a year ago but flat compared to the third quarter, suggesting uninspiring growth. Deposits fell 6% from a year ago and fell 2% from the third quarter as customers removed their funds to earn higher interest rates elsewhere.

Favorably, net interest income jumped 45% from a year ago, helped by the improved interest rate environment. The net interest spread jumped to 2.66% from 2.02% a year ago. However, fee income fell 46% due to lower deposit fees, lower investment banking activity and lower asset management fees. The net effect was that revenues fell 6%.

Expenses excluding all of the charges seemed reasonable at first look. Credit costs increased, as Wells added incrementally to its loan loss reserves. Favorably, the credit quality within the loan book remains high and reserves appear more than adequate.

Wells’ capital level, at 10.6% (CET1), is down from 11.4% a year ago, mostly due to the share repurchases in the first quarter, the bank’s dividends which have absorbed much of its earnings, and the effect of higher interest rates and wider spreads on its bond portfolio. However, its capital is well-above its 9.2% regulatory minimum and the bank is confident enough to say that it will resume its share repurchases in the first quarter.

All-in, a reasonable report at our initial review. We’ll need to dig in further over the weekend.

Friday, January 13, 2023, Subscribers-Only Podcast:

Covering recent news and analysis for our portfolio companies and other topics relevant to value/contrarian investors.

Today’s podcast is about 13 minutes and covers:

• Earnings
  
  • Wells Fargo & Company (WFC)
• Comments on other recommended companies:
  
  • Macy’s (M) – fractionally reduced its fourth-quarter guidance.
  • Ironwood Pharmaceuticals (IRWD) – fractionally reduced its fourth-quarter guidance.
  • Duluth Holdings (DLTH) – Holiday sales results were essentially in line with estimates.
  • Brookfield Re – article by the McKinsey consultants, found here https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/why-private-equity-sees-life-and-annuities-as-an-enticing-form-of-permanent-capital
  • Vodafone (VOD) – more turnover following the CEO’s departure.
  • Wells Fargo & Company (WFC) – trimming its mortgage operations.
  • Warner Bros Discovery (WBD) – raising the subscription price for HBO Max and also may sell its music library for around $1 billion.
• Elsewhere in the market:
  
  • What to make of the latest CPI report.

Please feel free to share your ideas and suggestions for the podcast and the letter with an email to either me at bruce@cabotwealth.com or to our friendly customer support team at support@cabotwealth.com. Due to the time and space limits we may not be able to cover every topic, but we will work to cover as much as possible or respond by email.