Today’s note includes an update on Wells Fargo’s (WFC) earnings. There were no ratings changes.
Next week, Baker Hughes (BKR), Dril-Quip (DRQ) and Vodafone (VOD) are scheduled to report. The earnings deluge begins the following week with 12 companies reporting.
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.
Second-quarter results were reasonable. Reported earnings per share of $1.38 compared favorably to a loss of $(1.01) a year ago during the depths of the pandemic and to profits of $1.02 in the first quarter of 2021. The results were much stronger than the consensus estimate of $0.92.
However, there were a lot of moving parts in the numbers. We made adjustments to arrive at a normalized $0.61/share in earnings.
The most visible adjustment was for the huge $1.6 billion reduction in the credit loss reserve, which in effect was considered a profit. Normalizing the reserve costs would reduce reported profits by about $0.38/share. We also removed $0.01/share for an asset-sale gain and a write-off. Results were also boosted by gains in non-core banking areas like venture capital and private equity, where the bank recognized $2.7 billion in gains, or about $2 billion more than normal, for another $0.38/share. We don’t know what the consensus estimate included, so the comparison of our $0.61 normalized earnings to the $1.38 consensus estimate is not valid.
On this normalized basis, return on tangible capital would have been about 7.3% – improving but only about halfway to the mid-teens target set out by management. If the bank were to show a mid-teens return on tangible capital on a normalized basis, which is its goal, the market would reward its shares with a higher valuation.
The bank is making progress with its expense cutting, as non-interest expenses fell 8% from a year ago. However, Wells remains hobbled by a glut of deposits but no new loans to absorb them, and by low interest rates. The net income margin fell to a narrow 2.02%, which led to net interest income declining 11% from a year ago.
Credit quality is robust and capital levels are now high enough (at a 12.1% CET1 capital ratio) that the bank committed to $18 billion of share repurchases over the next 12 months, and doubled its small dividend to $0.20/quarter. We sense that some of the profit-taking in alternatives/private equity and other gains was partly motivated by an effort to boost the bank’s capital ratios, hence the buyback program. In a frothy market, we’re fine with taking some profits and repurchasing discounted shares.
The bank is in perhaps the third inning of its turnaround, while the stock may be discounting fifth-inning progress, as the shares trade at about 1.29x its tangible book value per share of $34.95.
Ratings Changes
None.
Friday, July 16, 2021 Subscribers-Only Podcast
Covering recent news and analysis for our portfolio companies and other topics relevant to value investors.
Today’s podcast is about 7 minutes and covers:
- Brief updates on:
- Wells Fargo (WFC) – earnings show some turnaround progress.
- Nokia (NOK) – pre-announces a stronger outlook.
- Molson Coors (TAP) – reinstates the quarterly dividend at $0.34 and reiterates full-year 2021 guidance.
- Final note:
- In our sister publication, the Cabot Undervalued Stocks Advisor, we are starting a series on “how much to buy.” How much you own can be just as important as what you own.
Please join us for the 9th Annual Cabot Investor Conference, held online again this year, on August 17-19, that’s Tuesday – Thursday. You can see presentations by all of our analysts, which will include updates on their areas of expertise and discussions of their best picks.
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.
Disclosure: The chief analyst of the Cabot Turnaround Letter personally holds shares of every Rated recommendation. The chief analyst may purchase securities discussed in the “Purchase Recommendation” section or sell securities discussed in the “Sell Recommendation” section but not before the fourth day after the recommendation has been emailed to subscribers. However, the chief analyst may purchase or sell securities mentioned in other parts of the Cabot Turnaround Letter at any time.