This week is the start of earnings season. We review Wells Fargo’s (WFC) earnings and provide updates on several Cabot Turnaround Letter recommended stocks.
Also, note that we are raising our price target on Jeld-Wen (JELD) to 28 from 25.
Earnings reports by Cabot Turnaround Letter recommended companies:
Wells Fargo & Company (WFC) – Wells Fargo is a valuable and diversified major bank with extensive retail and commercial banking, mortgage lending, investment banking, credit card and investment management operations. 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 the potential for high credit losses from the pandemic-weakened economy. An additional constraint is a regulator-imposed cap on Wells Fargo’s asset size.
Now led by highly-credible CEO Charles Scharf, the bank’s operations and leadership are undergoing a complete overhaul. We expect a tightened compliance culture, better strategic focus and much more efficient operations to produce significantly higher earnings. We also expect Wells Fargo to successfully navigate the higher credit cost environment ahead.
In the third quarter, Wells reported earnings of $0.42/share, down about 45% from a year ago. The quarter included many charges and one-off items, so there is no effective way to “scrub” the number to properly compare it to the consensus estimate. In the June quarter, Wells reported a loss of $(0.66)/share.
On a year-over-year basis, Wells is performing worse. A key measure of profits, the “pre-tax, pre-provision profits,” which essentially is operating income before credit costs, fell 47%.
Revenues fell 14%, hurt by a 20% decline in net interest income. This source of revenues has been weakened by lower interest rates on its loans and securities. The net interest margin fell to 2.13% from 2.66% a year ago, reflecting the lower interest rate environment.
Fee income fell 9% but there were many one-off charges and benefits that make the comparison less clear. Mortgage banking revenues more than tripled, but the fall-off in an amorphous “Other” category more than offset this. Operating expenses were mostly unchanged.
Compared to a year ago, credit losses were only slightly higher, at a small 0.29% (annualized) of average loans, while reserves doubled. Capital remains sturdy, with the CET1 ratio of 11.4% ticking down modestly from 11.6% a year ago.
Compared to the second quarter, the bank produced 11% higher pre-tax, pre-provision profits. Slightly weaker net interest income combined with much higher fee income and modestly higher expenses. The biggest improvement from the second quarter came from much lower set-asides (reserves) for bad loans.
The bank is making (slow) progress with its restructuring. We expect that in a year or two it will have made major advances in its compliance and operational improvements. Low interest rates will continue to hobble profits, but this appears manageable.
The biggest unknown are the credit losses that loom ahead. If losses remained low, Wells would be out of the woods. Yet, like all banks, Wells has not likely seen the worst of the credit losses, and the eventually scale of the losses is unknowable. We don’t anticipate having a clear picture for a year. However, the bank has set aside $21 billion for future losses, compared to about $8 billion in non-performing loans. For the next few quarters, we expect Wells to set aside reserves or charge-off bad loans at a rate that will at least maintain its reserve base. This will dampen earnings.
We continue to be patient as Wells is still very early in its turnaround. Trading at 71% of tangible book value, the shares remain undervalued with large upside if the turnaround unfolds as we anticipate.
Friday, October 16, 2020 Subscriber-Only Podcast
Covering recent news and analysis for our portfolio companies and other topics relevant to value investors.
Today’s podcast is about 11 minutes and covers brief updates on:
- Wells Fargo (WFC) third quarter earnings.
- Peabody Energy (BTU) – our patience has just about expired.
- Baker Hughes (BKR) – some uptick in rig activity in the U.S.
- Albertsons (ACI) – initiated a $0.10/share quarterly dividend (2.8% yield).
- Jeld-Wen (JELD) – raising our price target to 28.
- Duluth Holdings (DLTH) – shares surge on upgrade from brokerage firm Baird. The shares have nearly doubled from our initial Buy recommendation and we are reviewing our price target.
- GameStop (GME) – a new buyer at 5.5%, and short-covering probably behind a lot of the recent surge.
- Consolidated Communications (CNSL) – we are losing patience with this turnaround, as they sold a 35% stake to a private equity firm to raise funds for their fiber build-out.
- Macy’s (M) – hired permanent CFO.
- Volkswagen (VWAGY) – reached a deal to acquire Navistar.
Final note – please join us on the Cabot Turnaround Letter webinar on Thursday, October 22, at 2pm. Click here to register.
To listen today’s podcast click here.
Please feel free to share your ideas and suggestions for the podcast 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 limit we may not be able to cover every topic each week, but we will work to cover as much as possible or respond by email.