University of Kentucky Student Research
Jonathan Ketterer
FIN 485
Sector:
Financial
Industry:
Financial Services
Wells Fargo & Co. WFC
TVA Investment Challenge
Instructor: Dr. Brad Jordan
3/5/2014
Recommendation: BUY
Current Price: 46.08
Margin of Safety: 15%
Target Price: 52.92
Highlights
Key Statistics
Economic Moat
Narrow
Wide
 World’s largest bank by market
cap, second largest by deposits in
the U.S.
 Diversified revenue s across 80
different business lines
 Holds a strong advantage in the
retail brand within the U.S.
Inside this report:
Economic Moat
2
Management
2
Peer Analysis
3
Profitability
4
SWOT Analysis
4
Valuation
5
Risk Factors
5
Investment Recom-
6
mendation
Market Cap
P/E
P/B
Div. Yield
Short %
257.96B
12.5
1.54
2.40%
0.65%
The Company
Overview
Wells Fargo and Company (NYSE:WFC) is an American banking and financial services holding company that is headquartered in San Francisco and services over 70
million customers across the globe. Primarily recognized for its retail operations in
the U.S., WFC has more than 9,000 branches and 12,000 ATM’s across all 50 states.
Established in 1852, WFC today is a result of many mergers, most notably one with
Norwest Corporation in 1998 and more recently one with Wachovia in 2008.
Business Model
WFC offers retail, commercial, and corporate banking services through physical
bank branches and offices, as well as through the internet. WFC’s customers are
composed of individuals, institutions, and businesses, and these customers are
mainly located in the U.S. (All 50 states and the District of Columbia) and in 35
countries. The main business that WFC engages in are: wholesale banking, mortgage banking, consumer finance, equipment leasing, agricultural finance, commercial finance, securities brokerage and investment banking, insurance agency and
brokerage services, computer and data processing services, trust services, investment advisory services, mortgage-backed securities servicing, and venture capital
investment. These operations are grouped for reporting purposes into three operating segments: Wholesale Banking; Community Banking; and Wealth, Brokerage,
and Retirement.
2
Economic Moat
Wells Fargo & Co. WFC
Jonathan Ketterer
FIN 485
TVA Investment
Challenge
Instructor: Dr. Brad
Jordan
WFC’s economic moat is moderate given the commodity-like nature of money and the
nature of the services it offers. A majority of the moat arises from the position of the
company as one of the four big banks that operate in America, the other three being
Bank of America (BAC), JPMorgan (JPM), and Citigroup (C). Among these three competitors, WFC is second in deposit market share, with growth in the past couple of
years that is closingthe gap between it and Bank of America. WFC is also well known for
its retail operation, providing banking services such as checking, savings, and
brokerage accounts to its customers, while still maintaining and growing its large commercial business. It is also worth noting that the customer base WFC has attracted is
rather sticky in nature in that it is typically a hassle for customers to switch their banking provider. Cross-selling products across this large customer base is also a strongsuit with WFC, providing it access to existing customers with its broad product variety.
WFC is also #1 in commercial real estate originations, middle market commercial
lending, small business lending, auto lending, mortgage origination, and mortgage
servicing. On the operational front, WFC is the most profitable amongst the big four
banks in terms of ROAE, ROAA, and Net Interest Margin. WFC is also a sec- tor
leader with its low efficiency ratio, which demonstrates its ability to maintain revenue
generation at a low cost.
Management
WFC has a management team composed of 7 long-tenured leaders. The CEO John G.
Stumpf has spent 31 years with the company or its predecessors, holding his current
position since 2007. CFO Timothy J. Sloan has also spent a good deal of his career
with the company or its predecessors, with 25 years in total, and 3 years in his current
role. The head of Wealth, Brokerage & Retirement Services is David M. Carroll, who
has spent 31 years with the company, but spent the first 25 with Wachovia, where he
was head of the Capital Management Group, which included retail brokerage, asset
management, and retirement and investment products. Controller Richard D. Levy
joined WFC at his current position in 2002, with 18 years of public accounting and
financial services prior to his onboarding. The head of the wholesale banking operation is David A. Hoyt. Hoyt has spent with 31 years with WFC. In all, the CEO’s direct
reports have an average tenure with WFC of 28 years. The tenured and experienced
management team at WFC displays a bright showing of consistency and performance.
University
of
Kentucky
Student
Research
3
3/5/2014
Peer Analysis
Competitors
WFC faces stiff competition from its main three competitors BAC, JPM, and C. On occasion, due to the similar
styles and metrics, WFC is also compared to U.S. Bancorp (USB), although the drastic difference in assets makes
this a less clear comparison. Amongst the big four banks, WFC leads the pack in most metrics, aside from valuation, and focuses heavily on retail operations as shown through its position as the #1 mortgage originator. In deposit market share and debit card issuance, WFC falls second to BAC, but is gaining in both segments while BAC
has seen declines. In regards to C, WFC fares (?) similarity in operations, but the focus of C on its international
seg- ments and merchant processing segment differentiates the two. JPM is about the middle of the road with
diver- sified revenues, but also has a larger exposure to investment banking and equity trading.
Key Statistics
While WFC has a higher P/E than most of the competitors shown here, this likely displays the premium that investors have agreed to pay for the profitability measures that are well ahead of the peer group. With an efficiency
ratio of 57.87%, WFC again leads the big four banks and displays an excellent ability to contain non-interest expenses associated with revenue generation. In terms of tangible common equity, WFC falls second only to C. In
this regard, however, WFC continues to compensate for its premium with profitability measures.
Ticker
WFC
USB
BAC
JPM
C
Mkt Cap
($000)
EPS LTM
257.07
78.80
183.57
230.62
152.34
3.95
3.01
0.94
4.36
4.36
P/E
12.58
14.37
11.32
9.17
10.24
Effic Ratio
OPM (%) 12/31/13
39.76
38.78
17.89
36.39
19.21
57.87%
54.86%
79.75%
62.62%
70.24%
Tot Assets
($000)
1,527
364
2,102
2,415
1,880
TCE Ratio
12/31/13
8.30
6.72
7.10
6.36
9.05
4
Profitability
Wells Fargo & Co. WFC
Ticker
ROAE LTM
ROAA LTM (%) (%)
Net Interest
Margin LTM
(%)
Noninterest Inc/
Operating Rev LTM
(%)
Jonathan Ketterer
C
0.75
7.11
2.93
37.84
FIN 485
BAC
0.53
4.89
2.46
50.15
JPM
0.75
8.64
2.23
53.59
USB
1.63
13.88
3.44
45.25
WFC
1.53
13.47
3.39
48.02
TVA Investment
Challenge
Instructor: Dr. Brad
Jordan
In terms of profitability, as seen from the chart above, WFC leads the big four with
outstanding metrics well-ahead of the peer group. As noted earlier, similarities can
be seen between USB and WFC given the two banks’ styles and heavy involvement in
wholesale and consumer banking. In this regard also, as shown earlier, the efficiency
ratio is worth noting when considering profitability. USB and WFC have shown excellent performance in keeping non-interest expenses to a minimum, likely given the
larger investment banking practices of BAC and JPM, and the equities trading operations of C and JPM, which also carry risk WFC has kept minimized through smaller
operations. The net interest margin represents here WFC’s ability to make more
money on its investments than its interest expenses, a crucial indicator of a healthy,
profitable bank. In the last column, noninterest income over operating reve- nue is
shown to display that WFC keeps a diversified stream of revenues, which come from
miscellaneous fees, brokerage & wealth services, insurance, and a small invest- ment
banking operation.
SWOT Analysis
University
of
Kentucky
Student
Research
5
3/5/2014
Valuation
In the valuation of WFC, I used SNL’s Bank Valuation Model, which allowed for input of asset yields
and asset growth rates, which I believe allowed for a
more specific valuation of the stock price. Yahoo!
Finance’s price target is a consensus of the sell-side
analysts that Yahoo! publishes. The Bloomberg Terminal’s DDM model provided a value that was right
in between that of the SNL price and Yahoo’s.
Valuation
Margin
Safety
SNL
Yahoo! Finance
7%
Bloomberg
P(DDM-PE)
11%
$56.87
23.4%
For the P(DDM-PE) model, using Value Line figAverage
$52.55
14%
ures and growth rates, the highest value of $56.87
was given. This appears bullish given Value Line’s estimate of an upside of $75.00 was well above that of most
sell-side analysts covering the stock. Given these fivevalues, the value I found to most accurately price the stock
was SNL’s model, considering it allowed for the input of factors other than those of the other models.
Risk Factors
WFC appears to be rather risk-averse when it comes to the financial sector, given its diversified revenue streams,
well-capitalized status, and its peer-leading profitability ratios. However, despite these large strengths, some risks
exist. WFC is very exposed to U.S. economy and its development as a whole. The understanding that most of
WFC’s assets are dependent on its customers paying them the interest and principal is a very broad way to look at
this situation. John Stumpf has said, however, that he believes interest rate risk is something that bankers should
be more concerned with than bad debt at this point in the economy’s cycle. While most banks, including WFC,
are in a position where they stand to benefit from rising interest rates, it is plain to see that investors would prefer to side with the more floating rate sensitive institutions. In this regard, WFC is well situated, but it has been
reported that it is not as floating rate sensitive as some of the other larger banks,. Another risk facing the company is the capital ratios that are set to be mandated in a few years. This should not be a problem as we see it now,
given that WFC is well-capitalized and on-track to meet those standards set forth by the Federal Reserve and Basel Committees. Another issue for WFC is that it has been made public that due to the slowdown in mortgage refinances and originations, WFC will plan to lower its credit score limit in its consumer lending practices. This
could make WFC more susceptible to bad credit issues, which predominantly caused the recession in 2008.
WFC is also heavily regulated as one of the largest banks and given its SIFI (Systemically Important Financial
Institution) status. WFC reports to many regulators. Among the most notable are the Office of the Comptroller of
the Currency, the Federal Reserve Board, the Securities and Exchange Commission, and the Consumer Financial
Protection Bureau. The Dodd-Frank Act of 2010 is also a concern for risk that has yet to be fully revealed. Within
this Act, risks lie in the CFPB’s creation, which monitors the retail operations of banks, of which WFC is very exposed to. The Volcker Rule also regulates the investment operations of banks, which may possibly put the growth
and operations of WFC’s investment banking and equities operations at risk.
6
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WfellalscFIanrcg.o &ACF
o.LWFC
Jonathan Ketterer
FIN 485
TVA Investment
Challenge
Instructor: Dr. Brad
Jordan
Investment Recommendation
WFC is, in my opinion, most certainly worthy of an investment of around 4.5-6% investment in our portfolio. I believe it matches the risk profile and return ability that we
are after. Also given the portfolio’s lack of financials beyond Aflac and Visa, it would be
wise to open up ourselves to some exposure, especially with the banking industry’s recently shown ability to return value to its shareholders through dividends and price
appreciation. WFC is also what I believe to be the best pick amongst the banks currently given its size as a big four, providing us with some moat, and through its profitability. Its industry-leading lending practices in real estate, consumer, small business, and
commercial markets makes it a largely obvious choice for meeting our portfolio’s aim
to find a moat. While C may appear to be more attractive on a valuation perspective
given its low Price to Book (75%), the international exposure to political risk and multiple interest rate environments may make this stock not as suitable for our portfolio as
WFC.
Sources
University

Bloomberg terminal

www.sec.com/edgar

www.morningstar.com

www.finance.yahoo.com

www.valueline.com

www.wellsfargo.com

www.snl.com
of
Kentucky
Student
Research