We review Barrick Gold’s preliminary report and Wells Fargo’s full report. Barrick continues to meet its production goals. Wells is taking what appears to be an aggressive approach to boosting its loss reserves and spoke about similarly aggressive cost-and-efficiency improvements ahead.
Both retain their Buy ratings and price targets.
Barrick Gold (GOLD) - The mining company provided preliminary 2Q results, with full results being reported on August 10.
Barrick said second quarter gold and copper production positions it well for achieving its full-year guided range. First-half gold production of 2.4 million ounces is at the mid-point of its full-year guidance for production of 4.6-5.0 million ounces.
The company said it can meet its full-year guidance range despite 2Q production falling 15% due to Covid-related issues and lower production at its Porgera mine in Papua New Guinea as the local government attempts to expropriate the mine.
Barrick also noted higher costs in the quarter.
Earlier, Barrick commented that its Nevada Gold Mine, the joint venture that combines Barrick’s and Newmont’s operations in Nevada, has had “exceptional performance”. This is encouraging as the combination seems like an obviously good idea.
We continue to rate Barrick Gold (GOLD) shares a Buy with a $30 price target.
Wells Fargo & Company (WFC) - The bank reported a loss of $(0.66)/share, or $(0.57)/share adjusted for one-off costs, compared to estimates for a loss of $(0.15). Most of the “miss” was due to the bank’s increase in its loan loss reserves, which were about 2x what analysts had estimated. Also, fee income was lower than estimates. During most of the April-June quarter, the U.S. economy was under stay-at-home restrictions. Wells has little business outside of the country.
Wells cut its dividend by 80%, to $0.10/share per quarter. This rate was set with the difficult regulatory and earnings outllook in mind, and management believes that it can be sustained indefinitely barring a sharp further downturn in the economy.
Wells Fargo is in a weaker capital, profit, and operating efficiency position relative to its banking peers. These weaknesses exacerbate the risks from the rising Covid-related credit costs.
Much of our thesis on Wells is driven by its ability to weather the credit storm, with a significant additional opportunity to boost profits by becoming a much more cost-efficient and risk-controlled bank, led by its new and highly-capable management team. Wells has a strong business franchise in key segments of the economy, with durable liquidity and an adequate capital base, with its shares trading at a low .80x tangible book value. The bank is in the very earliest stages of its turnaround.
On its lengthy 1-hour 51-minute conference call (31-page transcript), one of the longest of any company in memory, Wells provided color on the business, current conditions and its strategy.
Net interest margin (its interest-based profits from lending) which comprises about 55% of total revenues, fell 13% from a year ago due to the lower interest rate environment. The bank expects little change over the rest of the year.
Non-interest income (fees on everything from checking accounts to investment banking and trading) increased by 24%, mostly due to gains in its equity portfolio. Consumer-based fees generally were weak as economic activity was slower. Wells has a much smaller trading/investment banking business relative to the other major banks, particularly Goldman and Morgan Stanley. In recent years, this low exposure was a positive as these kinds of operations suffered from lower volumes and profits. However, in the currently volatile markets, trading/investment banking is now producing high counter-cyclical profits and thus is newly-desired. Wells is at a disadvantage here.
The bank charged off $1.4 billion in bad loans, about 33% higher than a year ago. Charge-offs should ramp up in coming quarters as various bank-led and government-led relief programs expire, and as the delayed effects of the economic downturn reach their full impact. In anticipation, the bank increased its reserves for losses by $9.6 billion (compared to the $3.8 billion increase in the first quarter and $503 million a year ago). Much of the higher losses could come from Wells’ real estate lending portfolio, as the bank is the nation’s largest commercial real estate lender. However, the bank believes its collateral position is strong, which should somewhat limit its losses. Commercial real estate and the related commercial mortgage-backed securities portfolio bear close watching.
Wells Fargo did not provide much useful color on when total loan losses would reach a peak nor on what the peak size would be. They characterized the large reserve build as being “extremely cautious” and “prudent”. Wells’ reserves are at about 71% of its stress-test loss reserves, whereas peers are mostly in the 50-62% range, indicating Wells’ aggressive reserve-taking.
Expenses were 8% higher than a year ago, partly due to spending on Covid-related safety and other measures.
Despite the loss, the bank’s regulatory capital ratio (CET1) increased to 10.9%, with a decent $23.7 billion cushion above the 9.0% regulatory minimum. Its tangible book value ended the quarter at $31.88/share, down $1.02/share from the first quarter and down 5% from a year ago. Liquidity remains robust.
Wells continues to strain under the asset cap. While the cap forces the bank to be much more efficient with its capital, and reduces the pressure on its capital ratios (clearly a positive given the rising credit costs), it also weighs on the bank’s profits. Lower profits in turn hurts its capital strength. So, while the cap made a lot of sense under the previously weak and loose management team, it is a significant constraint under the new and risk-aware management team. However, we don’t see relief for at least a year.
Under the new and impressive CEO, Wells is getting its otherwise ragged house in order. The company will unveil its new 5-segment structure next quarter, many of which will be led by outsider executives hand-picked by CEO Scharf. Wells is creating credible and capable risk and control structures to both reduce its risks and increase its chances of getting regulatory relief. Also, is appears that most of the senior leadership team overseeing operations, admin, government relations, and other key functions within the company have been replaced with outsiders or by selected internal promotions.
On the conference call, Scharf stressed the bank’s high expense base, suggesting that its expenses are as much as $10 billion too high. For scale, reducing expenses by this amount, by itself, would add nearly $2/share in after-tax net income. Scharf provided some color on the sources of the bloat, and sounded determined to meaningfully cut costs yet improve the bank’s overall competitiveness. We think he is capable of achieving much of his goals here. The company will likely provide a more detailed strategic plan later in the year.
We remain confident in our Wells thesis, acknowledging the risks from the yet-unpredictable ultimate size of its credit losses.
We continue to rate Wells Fargo (WFC) shares a Buy with a price target of $43.
Disclosure Note: One or more employees of the Publisher own shares of all Turnaround Letter recommended stocks, including the stocks mentioned in this note.