2023-09-28 10:00:00 ET
Summary
- Wells Fargo has been working to improve efficiency ratios via reducing operating costs, but still has room for improvement compared to other banks.
- The bank has been actively repurchasing shares and reducing its share count, positioning itself for future EPS growth.
- The stock is cheap at 8x EPS targets.
The banking sector has had a rough year leaving a leading financial like Wells Fargo ( WFC ) trading not far off the recent lows. The banking sector has been under pressure all year due to recession fears and the regional banking crisis leading to potentially higher capital requirements. My investment thesis remains ultra Bullish on the stock due to tons of future upside from efficiency efforts and eventual growth from removal of the asset cap.
Efficiency Path
Wells Fargo has been on a long quest to greatly improve the efficiency of their banking operations. Following the fraud crisis, the large bank had a bloated operating structure and an asset cap implemented by the Fed limiting growth.
The bank has spent the years since hiring Charlie Scharf as the CEO cutting the employee counts. The bank is now down to only 234K employees at the end of Q2 from a peak level about 40K higher in 2021 due to some delays in restricting with Covid prevalent.
The problem here is that Wells Fargo would ideally add employees similar to JPMorgan Chase ( JPM ). The largest bank is able to add employees and still generate about 50% more revenue per employee as compared to the $303K of Wells Fargo.
Bank of America ( BAC ) has a far larger revenue base and still has 22K less employees than Wells Fargo leading to similar revenue efficiency levels per employee. Per the CFO, the bank appears set to make additional workforce cuts.
The bank had once targeted eliminating $10 billion in annual costs, but the recent massive string of rate hikes has made absolute operating expense cuts less necessary. The whole goal is to improve efficiency levels and higher interest income helps offset some of the need to eliminate costs as much as control the rise along with higher NII.
Wells Fargo was targeting $50 billion in noninterest expenses for 2023 and has now guided up to ~$51 billion. The expenses are already down from $54 billion (ex-remediation and restructuring costs) entering the efficiency plans and some of the expenses included in the updated 2023 estimate are related to severance costs.
Even with the higher deposit costs, Wells Fargo is still targeting a nearly $13 billion quarterly NII rate. The rate is far above the 2022 quarterly levels.
Due to ongoing regulatory issues, Wells Fargo has reinvested some of the cost savings into updating risk systems. The bank will continue working on efficiency, such as the ongoing employee cuts, but investors probably shouldn't factor in huge cost reductions going forward as much as boosts from higher income.
EPS Machine
Due to some of the short-term crunches with higher deposit costs, credit costs and spending on system enhancements, Wells Fargo has seen the EPS targets stick to around $5. The upside potential will come from the lift of the asset cap, share buybacks and ultimately more efficiency gains over time with the bank far below the levels of JPMorgan and BoA with a ratio of only 63% in Q2'23.
The share buybacks have been ~$8 billion in the 1H of the year. The large bank is still spending aggressively on repurchasing shares, but the amounts will likely be lower in the short term.
Still, Wells Fargo has again cut the diluted shares outstanding to below 3.7 billion shares. The large bank has reduced the share count by over 1 billion in the last 5 years and the stock is even lower now despite the better financial position going forward.
The banking sector in general, and Wells Fargo specifically, have gone through a ton of hiccups the last few years. The key is that the large bank continues making a ton of progress making the business more efficient and lowering share counts while now offering a solid 3.4% dividend yield to wait on a better market.
The stock trades at only 8x EPS targets while JPMorgan trades at closer to 10x after not rallying for a couple of years now. All of the bank valuation multiples are depressed with the current market fears of a recession and higher capital ratios.
Takeaway
The key investor takeaway is that bank stocks are currently priced for the worse possible outcomes of higher capital ratios via proposed Basel III rules and recession fears.
Investors should continue using weakness in Wells Fargo to snap up the solid dividend and potential for the large bank to grow earning during a normal banking environment. In the meantime, the bank will continue repurchasing cheap shares and lowering the diluted shares outstanding.
For further details see:
Wells Fargo: Rough Times Will Eventually Turn