After Impressive Earnings WFC Stock Is Clearly Undervalued

Shares of struggling banking giant Wells Fargo (NYSE:WFC) popped in mid-October after the company reported third quarter numbers that were largely better than expected, and fairly impressive considering all the recession chatter out there. As of this writing, WFC stock is up more than a percent on the Q3 print.

After Impressive Earnings WFC Stock Is Clearly Undervalued

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Here’s the story. Wells Fargo was supposed to report awful numbers. The U.S. and global economies are growing at their slowest pace since the Recession, interest rates have plunged to near all-time-lows, and the yield curve is essentially flat.

That’s a bad operating backdrop for banks, so banks were broadly expected to report bad numbers this earnings season, especially Wells Fargo, which has been the eyesore in an already struggling banking sector thanks to brand reputation issues.

Indeed, Wells Fargo’s headline Q3 numbers were a mixed bag. Revenues beat. Earnings missed, dragged by a plunge in net interest income thanks to a plunge in interest rates. But, underneath those headline numbers, there were a lot of pockets of strength in Wells Fargo’s Q3 print. That is, Wells Fargo’s banking, customer, and loan activity remains very healthy despite slowing economic conditions while the bank’s reputation appears to be rebounding.

Zooming out, then, Wells Fargo Q3 print was actually pretty good. All Well Fargo really needs to “fire on all cylinders” is for global economic activity to rebound and interest rates to inch higher.

I think both of those things can and will happen over the next 12 months. As they do, I expect WFC stock (which currently sports a relatively discounted valuation) to march higher.

Wells Fargo Earnings Were Impressive

Wells Fargo’s Q3 earnings were impressive, considering the backdrop in which the bank was operating during the quarter.

That is, the global economy has slowed dramatically over the past two years and is now growing at its slowest pace since 2009, according to the IMF.

Wrapped into the slowdown, manufacturing-related industries everywhere are contracting thanks to backlash from the U.S.-China trade war, while services-related industries are slowing as the trade war is having a ripple effect across the whole economy. Business confidence levels globally are plunging. Consumer confidence levels are starting to lose their footing. Enterprise capex is down.

In other words, a lot is going wrong in the global economy. At the same time, the borrowing environment is awful for banks, as interest rates are near all-time lows and the yield curve is flat.

Net net, banks like Wells Fargo were supposed to report awful numbers. But, they didn’t. Wells Fargo didn’t. Most things were up in the quarter. Checking customers were up. Credit card and debit card usage was up. Loan volume was up. Deposits were up. Customer satisfaction scores were up.

Broadly, Wells Fargo reported an “up” quarter in a “down” economy. That’s impressive. It speaks to two things. First, it speaks to Wells Fargo’s resiliency in a slow-growth economy. Second, it speaks to the fact that Wells Fargo’s reputation, which has been damaged by various discrete events over the past few years, is rebounding.

The investment implication? If global economic activity picks up steam from here and interest rates march higher, Wells Fargo will fire on all cylinders, and WFC stock will go higher.

Wells Fargo Stock Can Go Higher

I think that is exactly what will happen.

Right now, the biggest drag on the global economy is the U.S.-China trade war, both because it is having direct impacts via tariffs and trade disruption, and because it is having indirect impacts via depressed business and consumer confidence. But, trade tensions are de-escalating meaningfully, and both the U.S. and China appear very willing and open to striking a series of trade deals over the next few years to prevent their respective economies from stumbling into a recession.

This de-escalation will continue into 2020. At the same time, central banks everywhere are coming off several months wherein they injected a tremendous volume of fiscal stimulus into the global economy.

Just look at the Hutchins Center Fiscal Impact Measure, which shows how much local, state, and federal fiscal and monetary policy is impacting overall economic growth in the U.S. According to that metric, the U.S. economy has been injected with more fiscal stimulus throughout 2019 than it has been since the Recession.

Big picture? In 2020, trade tensions will de-escalate, and the global economy will get a lift from huge 2019 stimulus packages. Global economic activity will rebound. Interest rates will move higher. The yield curve will normalize, and, importantly, Wells Fargo’s numbers will meaningfully improve, especially on the all-important net interest income front.

The result? WFC stock will move higher. I realistically think that, if economic activity does rebound and interest rates power higher, Wells Fargo could do about $5 in FY21 EPS. Based on a financial-sector-average 12-times forward earnings multiple, that implies a FY20 price target of $60.

That’s where WFC stock will head by the end of 2020.

Bottom Line on WFC Stock

Wells Fargo’s impressive third-quarter numbers underscore that all this company needs to propel a huge rally in WFC stock is for the trade war to cool off. That should happen over the next 12 months. As it does, Wells Fargo’s numbers will improve, and WFC stock will trend higher.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.

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