There was plenty of hip, hip, hooraying going over Wells Fargo (NYSE:WFC) last week after its first quarter earnings report that showed $5.1 billion in profits, an impressive 22% increase compared to the first quarter of 2012. Earnings per share came in at 92 cents a share, which was four cents over estimates.
Once the excitement died down, attention was turned to how Wells Fargo fared in mortgage lending. Unfortunately, these numbers were not nearly as exciting. The reasons for the decline do not appear to be due to one-time occurrences. Instead, they indicate that rougher times may lie ahead in the near term. Still, on balance the bank’s fundamentals are strong, making it a viable short-term value play.
Troubled Waters in the Country’s Largest Lender
Because Wells Fargo is the country’s largest lender, it is natural to assume that if business shows signs of improving, it can be a strong indicator about how the overall housing market is faring. The bad news on this front was that Wells Fargo reported mortgage revenues for the first quarter totaled $2.8 billion, which represented a 9% decline from a year ago. Also declining during the first quarter were the company’s mortgage origination volumes. They fell 13% to $109 billion. It was obviously a mixed report.
Management Still Optimistic
Wells Fargo CEO John Stumpf said the bank was still bullish about the mortgage business.
“The mortgage business is still very strong. At $109 billion, as we mentioned, it’s our sixth consecutive quarter of originations above $100 billion,” Stumpf said.
He added that the bank saw an increase in purchase activity in the first quarter, up 31% year over year.
“I think the other positives in the business are we’ve now seen an extension of the [Home Affordable Refinance Program] and with rates rallying again, we’ve got more customers that could take advantage of a refinance, as well as the fact that as housing values go up, there would be more customers that could potentially take advantage of a refinance.”
While we appreciate the optimism, there are some factors that must be taken into account in evaluating how the bank’s mortgage business will fare in the near term. One of the more interesting things was pointed out last month by CNBC, which reported that regular homebuyers are facing increased competition from investors looking to buy homes in bulk. These investors, such as hedge funds, don’t need to secure mortgages; they deal in cash. As they set their sights, and dollars, on properties, they are driving up prices and scooping up the supply of houses that are available.
Wells Fargo Fundamentals
Despite the mixed report, we think WFC represents a strong opportunity to the upside in the short term. Tuesday’s housing starts and building permits numbers were also a little mixed but stable. This should continue to support rising prices and activity in the housing sector.
Compared to peers, the stock was quite defensive during Monday’s sell-off and rising housing prices should end the lull in the mortgage business in the next quarter. While not a perfect measure, valuation ratios for WFC are attractive among its peer group. Take its price to earnings ratio, for example. It was 10.35, compared to 48.33 for Bank of America (NYSE:BAC) and 16.43 for Citigroup (NYSE:C). Only J.P. Morgan (NYSE:JPM) and its very ugly balance sheet had a lower P/E ratio at 8.35.
Returning more capital to its shareholders remains a priority; it increased its common dividend to $0.25 a share. Stumpf said the bank’s capital plan for this year will help it to further increase its dividend rate to $0.30 a share in the second quarter. The bank will also be able to increase its common stock repurchases in this compared to its 2012 repurchase levels. If the market does get a little choppy in the short term, the attractive dividend should help the company from a defensive perspective as it catches up with Citigroup.
Click to Enlarge From a technical perspective, we have set our sights on a short term move to the upside. The retracement against the prevailing bullish trend in March and April hasn’t been very deep but the first projection level based on the depth of that move is just over $39 per share. As you can see in the next chart, that is our short term target. It wouldn’t be unreasonable to expect that move to complete before the end of May.
Recommendation: Buy WFC at support with a short-term $39 target. However, this also seems to be an attractive entry point for longer term investor looking to buy high value stocks in the financial sector before the next rally.
Options Alternative: Buy to open the May out-of-the-money calls at the $38 strike for 25 cents per share or less. Liquidity at that strike price looks solid, and the premium has dropped significantly since earnings.
Investor Place advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.