We are upgrading our rating on Wells Fargo as investors dump stock post-earnings

Published Fri, Jul 12 20243:06 PM EDT

Shares of Wells Fargo took a hit on Friday after the bank reported a beat on earnings but delivered softer guidance due to the uncertain economy and interest-rate environment. We see the drop as a chance to buy more shares. Total revenue for the three months ended June 30 ticked up less than 1% over last year, to $20.69 billion, exceeding analysts' expectations of $20.29 billion, according to LSEG. Adjusted earnings of $1.33 per share was also above Wall Street's consensus estimate of $1.29 per share, LSEG data showed. Wells Fargo Why we own it : We bought Wells Fargo as a turnaround story under CEO Charlie Scharf. He's been making progress cleaning up the bank's act and fixing its previously bloated cost structure after a series of misdeeds before his tenure. Scharf has also been working to get the Fed's $1.95 trillion asset cap lifted and to boost Wells Fargo's fee-generating revenue streams. Competitors : Bank of America and Citigroup Weight in Club portfolio : 4.76% Most recent buy : Feb. 24, 2022 Initiated : Jan. 8, 2021 Bottom line The miss on net interest income was less than ideal, but this metric is largely driven by forces out of the bank's control. Higher interest rates incentivized depositors to reallocate funds to higher-yielding instruments, resulting in a slightly lower-than-expected net interest margin (and income). Full-year guidance for continued struggles in this area was the fly in the ointment Friday, sending shares of Wells Fargo down nearly 6%. However, we were pleased to see how Wells performed in an area it does control: its growing fee-based business. Non-interest (fee-based) income came in well ahead of expectations, up nearly 19% versus the year ago period. This growth has been a key reason for us sticking with the stock as it makes the bank less reliant on the dynamics of the yield curve and gives management more control over the firm's destiny. We are more excited by the outperformance of non-interest income than we are disappointed with the miss on net interest income. Moreover, Wells Fargo's return on tangible common equity, a key metric that supports a higher valuation multiple, came in ahead of expectations. The bank's efficiency ratio (non-interest expense divided by total revenue, the lower the better), common equity tier 1 (CET) ratio (which compares a bank's capital against its risk-weighted assets), and tangible book value per share (TBVPS) results were all in line with expectations. In addition, we appreciated management returning $6.1 billion to shareholders via the repurchase of 100.5 million shares, and another $1.2 billion via common stock dividends. Management continues to expect the third-quarter dividend to increase 14%, to 40 cents per share (from 35 cents), pending approval by its board of directors. The pace of share repurchases is expected to slow, the team added, but the common equity tier 1 (CET) — the minimal level of the bank's highest capital required by regulators — was at 11%, well above the firm's current 8.9% regulatory requirement. This means there's still plenty of excess capital left for management to return to shareholders over time. We trimmed our Wells Fargo position last Friday on concerns of a sell-the-news reaction to bank earnings. Despite this quarter's disappointing NII results, the long-term turnaround story remains the same. The company continues to work through regulatory hurdles and fines put in place after the company's sales practices scandals of the late 2010s. This should move the bank closer to having its $1.95 trillion asset cap lifted, which was the most severe punishment put in place by regulators back in 2016. It's not clear when this will happen, but it is a material positive catalyst for shares. For all these reasons, we view Friday's pullback as a buying opportunity and are upgrading our rating on Wells Fargo shares to a 1. We reaffirm our $62 price target. Guidance Wells Fargo's management team maintained its outlook for full-year 2024 net interest income to be about 7% to 9% lower than the $52.4 billion level achieved in 2023 — and likely to be closer to 9%. However, the team added, many of the factors driving net interest income are uncertain heading into the second half of the year. An 8% decline would mean roughly $48.21 billion in NII, below the $48.68 expected on the Street. It was this guidance that drove shares of Wells Fargo down Friday, more than anything else. We don't like to see guidance misses, but bank interest income estimates depend on interest rates, which Wells Fargo has no real control over. With inflation cooling and the Fed likely to cut rates at least once this year, the team said it expects NII will "trough" towards the end of the year. Compounding the sub-optimal update on net interest income, non-interest expense guidance was increased to roughly $54 billion, up from the approximately $52.6 billion previously forecast. That's also above the $53.11 billion expected. On the release, management attributed the increased expense outlook to higher revenue-related compensation due to equity market outperformance versus expectations, higher than previously expected operating losses and "other customer remediation-related expenses" and the realization of a $336 million FDIC special assessment expense in the first half of the year for the rescue of regional banks after last year's failure of Silicon Valley Bank. As it relates to the higher revenue-related compensation, keep in mind that an upward revision here is never a bad thing because this expense is variable and related to revenues, meaning that any expense increase on this front gets more than offset by an increase in non-interest income. Second-quarter results Consumer banking and lending revenue fell nearly 5% year over year to $9.01 billion. Consumer and small business banking (CSBB) revenue fell 5% on the back of lower deposit balances and customers moving money to higher-yielding deposit products, including promotional savings and time deposit accounts, such as CDs. Within consumer lending, home lending was down 3% versus last year and down 5% sequentially. Credit card revenue was unchanged versus the year-ago period and down 3% on a sequential basis. Auto loan revenue was down 25% year over year and down 6% sequentially. Personal lending fell 4% from last year. Non-interest expenses fell 5% thanks to lower operating costs and cost-cutting measures. Commercial banking revenue fell 7% to $3.12 billion. Middle-market banking revenue declined 2% year over year, while asset-based lending and leasing revenue was down 17% annually. Non-interest expenses fell 8% year over year on lower personnel expenses. This reflects the impact of efficiency initiatives, and lower operating costs, the company said. Corporate and investment banking revenue increased 4.5% to $4.84 billion. Total banking revenue increased 3% year over year, driven by a 38% increase in investment banking revenue, partially offset by a 10% decline in treasury management and payments revenues. Lending was up marginally versus the year-ago period. Commercial real estate revenue fell 4% as the headwind of lower loan balances was only partially offset by increased commercial mortgage-backed securities volumes. On the call, management said that while losses in the commercial real estate office portfolio increased in the second quarter, after declining last quarter, they were in line with our expectations. The team added that these losses "have been and a will continue to be lumpy as we continue to work with clients." Wells is continuing its effort to de-risk the bank's office exposure, and have so far managed to reduce Wells Fargo's office commitment by 13% and loan balances by 9% from a year ago. Markets revenue was up 16% versus the year-ago period on the back of an 8% increase in fixed income, currencies, and commodities (FICC) revenue, and a 41% increase in equities revenues. Non-interest expenses increased 4% annually, due to higher operating costs, which were only partially offset by efficiency gains. Wealth and investment management revenue increased nearly 6% to $3.86 billion. Net interest income fell 10% year over year as deposits declined and the interest paid for those deposits increased as customers reallocated cash into higher-yielding securities. Non-interest income increased 12% thanks to higher asset-based fees driven by an increase in market valuations. Non-interest expenses rose 7% annually as higher revenue-related compensation and an increase in operating losses was only partially offset by lower operating costs and efficiency initiatives. (Jim Cramer's Charitable Trust is long WFC. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

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