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Why Wells Fargo Is Rallying After Weak Earnings

Last week, Wells Fargo (NYSE:WFC) put out its second-quarter earnings report. It was not well-received. The bank showed disappointing earnings, mounting credit quality issues, it slashed its dividend, and it suggested that it will have to fire a massive number of its employees going forward. Sounds like a disaster, right? Yet WFC stock has traded higher since the report. What’s going on here?

If You Own Wells Fargo Stock, Non-Interest Income Is a Real Worry
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As I wrote a few weeks ago, the bottom was already in for Wells stock.

Indeed, Wells Fargo hit its low at $22 in May. On Q2 earnings, it fell no lower than $23.50, and now it’s already back up to $26. Here’s why investors are buying up the bank despite the lousy results last quarter.

The Layoffs Are a Positive

Wells Fargo generated a ton of attention when it said that it will need reduce its headcount by many thousands of employees. CEO Charlie Scharf suggested that Wells Fargo will cut $10 billion in annual expenses. Yes, $10 billion. For context, the company brings in $60 billion a year in revenues, and generated roughly $15 billion a year in profits before the novel coronavirus hit.

So $10 billion is an absolutely massive move – we’re talking something like $1.50 to $2 share in annual added EPS if that target is achieved, even accounting for taxes. Wells Fargo reliably earned $4 per share per year in recent times. So, once it gets these costs cut, we’re looking at the bank earning at least $5 if not $6 per share going forward every year. That adds up to a sub-5 price-earnings ratio.

But won’t the layoffs hurt the bank’s future profitability? It’s a risk. Consider, however, that much of Wells Fargo’s bloat is due to elevated legal and compliance costs. Those are a result of the bank’s fake accounts scandals from a few years ago. As time goes on, the bank will clean up its associated liabilities with those events and be able to reduce its personnel devoted to that task.

Additionally, Wells Fargo is currently facing a Federal Reserve-imposed asset cap due to said scandal. As such, it can’t expand its loan base, and thus needs fewer loan officers for now. Those layoffs won’t impact the bank’s profit-making abilities significantly.

Many Problems Aren’t Unique to WFC Stock

Wells Fargo has one big problem of its own making: The unauthorized accounts scandal from a few years ago. We’ve known about that for awhile, and Wells is working on fixing it. They brought in Charlie Scharf, Visa’s (NYSE:V) high-powered former CEO, as an influential outsider to turn things around.

The other negatives in this earnings report are hardly unique to WFC stock, though. Most banks with energy lending exposure are taking provisions there. It’s hardly Wells’ fault that oil companies are struggling with crude at $40. Ditto for commercial real estate with shopping malls and offices shut due to stay-at-home orders.

Wells Fargo’s mortgage servicing business is also hitting short-term bumps due to people not paying their rent or mortgage payments on time. However, there’s little reason to think that these non-payments will continue indefinitely.

You can find plenty of issues with individual components of Wells’ business, but that’s true of most national banks right now. And Wells Fargo has plenty of bright spots. For example, investment banking is on a roll with the tech boom creating tons of initial public offerings and other fundraising opportunities.

Competitive Position Hasn’t Changed

In 2020, year-to-date, Wells Fargo has lost half its value. Meanwhile, the median national bank is down around 30%. Some are faring even better. Goldman Sachs (NYSE:GS) is nearly flat for the year. Wells Fargo stock already traded at a scandal discount back in 2019. Now we’ve got another big divergence from peers on top of the prior one.

It’s pretty incredible, as Wells Fargo used to be the highest-priced of the major U.S. banks. On a price-book value ratio, which measures a bank’s valuation against its financial assets, Wells Fargo was reliably among the most expensive big banks in the U.S. Now it’s one of the cheapest.

In fact, Wells Fargo is selling for less than 0.8 times book value. It regularly used to sell for almost 2 times book value before the scandals hit. Now, the gold standard of U.S. banks is JPMorgan (NYSE:JPM), which is selling for 1.3 times book value. Well Fargo, which used to get a higher valuation than JPMorgan, now goes for just 60% of its rival.

Yet, when you look at past results, Wells Fargo has consistently earned significantly higher returns on assets and returns on equity – two key banking metrics – than JPMorgan over the past decade. Even in 2019, the company only modestly lagged JPMorgan in operating profitability metrics. There’s a good chance it will catch back up as its cost-cutting measures take effect.

WFC Stock: It Gets Better From Here

It’s telling that Wells Fargo has traded higher since the latest earnings report. That report was filled with all sorts of bad news, including making the massive dividend reduction official.

Yet the market saw right through the numbers and looked to the future.

Wells Fargo’s biggest problem – inefficiency – is now being handled. Scharf has autonomy to do whatever is necessary to fix the bank, and he’s going at it full bore. He’s targeting an incredible $10 billion a year in cost savings. And, already, he’s gotten all the bad news out of the way on the dividend and increasing loss provisions over the past two quarters.

From here, Wells Fargo will generate improving results, and a rising stock price along with it.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned GS and WFC stock.


Article printed from InvestorPlace Media, https://investorplace.com/2020/07/why-wells-fargo-is-rallying-after-weak-earnings/.

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