Wells Fargo stock (NYSE: WFC) dropped greater than 53% – falling from $54 in the conclusion of 2019 to approximately $25 in late March – that is also the present degree.
This could be attributed to two factors: The Covid-19 outbreak and financial downturn intended that market expectations for 2020 along with also the near-term consumer demand plummeted. This may negatively impact individuals and businesses, affecting their loan repayment capacity and exposing Wells Fargo to large loan losses. Though the multi-billion-dollar Fed stimulation provided a ground and a number of Wells Fargo’s peers profited from it, the same wasn’t true for the bank because of comparatively smaller existence in sales & trading and investment banking companies.
But, we believe investors Stay over-cautious about Wells Fargo’s stock
Trefis quotes Wells Fargo’s evaluation to be approximately $31 per share – roughly 15% over the present market price – according to an approaching trigger clarified below and a single risk element.
The cause is a better trajectory for Wells Fargo’s earnings over the next half of this year. We expect the company to report $73.2 billion in earnings for 2020 – approximately 14% lower compared to the amount for 2019. Our prediction stems from our belief that the market is very likely to start up in Q3. The easing of lockdown constraints in the majority of the planet is very likely to aid consumer demand, leading to greater business spending. Wells Fargo has a comparatively smaller presence in investment banking and the Sales & Trading area when compared with its peers. Because of this, it’s not gained out of a jump in trading volumes in the securities marketplace and greater underwriting deals following the Fed stimulation. In general , we see the company reporting an EPS of around $0.74 for FY2020.
ThereafterWells Fargo’s revenues are expected to improve to $74.4 billion in FY2021, mainly due to improvement in consumer banking and commercial lending revenues. Further, the net income margin is likely to improve as compared to the previous year due to a decline in provisions for credit losses, leading to that an EPS of $2.63 for FY2021.
Finally, how much should the market pay per dollar of Wells Fargo’s earnings? Well, to earn close to $2.63 per year from a bank, you’d have to deposit about $285 in a savings account today, so about 110x the desired earnings. At Wells Fargo’s current share price of roughly $25, we are talking about a P/E multiple of just below 10x. And we think a figure closer to 12x will be appropriate.
That said, Banking is a risky business right now. Growth looks less promising, and near-term prospects are less than rosy. What’s behind that?
Wells Fargo originates and services the largest number of mortgages in the USA. Further, it has a huge portfolio of consumer, commercial, and wealth management loans – around $932 billion in FY2019 with roughly $320 billion in outstanding mortgages. The economic downturn could negatively affect the loan repayment capability of its consumers, exposing the bank to significant loan defaults. As a result of this exposure, the bank has increased its provisions for loan losses to around $13.5 billion by Q2 2020– roughly 10x of the year-ago period, leading to a huge spike in total expenses for the year. If the economic condition worsens, this figure could further increase in the subsequent months. Additionally, a negative economic outlook will make it expensive for the bank to attract funding, increasing the cost of its operations.
The same trend is visible across Wells Fargo’s peer – Bank of America. Its core banking revenues are likely to suffer in FY2020 because of a lower interest rate environment. Further, its margins are likely to drop due to build-up in provisions for credit losses in anticipation of bad loans. However, unlike Wells Fargo, positive growth in its trading arm and investment banking business in FY2020 would more than offset the weak core banking earnings. This would explain why Bank of America’s stock currently has a stock price of over $24 but looks slated for an EPS of around $2.43 in FY2021 (for a P/E multiple of nearly 12x).
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