Wells Fargo Sees Growth Ahead


Wells Fargo & Co. (WFC) is well positioned to grow its business in the years ahead. At its annual investor day event held earlier this week, the company had come out of financial crisis well and achieved nine consecutive quarters of earnings per share growth.

Wells Fargo announced its target of return on assets of 1.3% to 1.6% and return on equity of 12% to 15%, subject to economic and regulatory environment. This is likely to support a shareholder payout ratio of about 50% to 65%.

Wells Fargo’s average return on assets between the first quarter of 2009 and 2012 is 1.12% and average return on equity for the same period is 10.97%.

Moreover, with a strong capability to generate organic capital, Wells Fargo is well positioned for future attractive acquisition opportunities but will adhere to discipline while assessing such deals. Notably, since 2011, the company has completed six transactions which include both loan portfolio purchases as well as business unit acquisitions.

Notable among these were the purchases of BNP Paribas North American Energy Lending, Burdale Financial Holdings Limited from Bank of Ireland Group (IRE) and EverKey Global Partners. These deals were completed in 2012. Wells Fargo also made loan portfolio purchases from Irish Bank Resolution Corp., Bank of Ireland and Allied Irish Bank in 2011.

Additionally, the company has agreed to buy San Francisco and New York City-based Merlin Securities LLC, and the deal is pending at this moment. The company plans to expand its operations in international markets and augment its asset management business.

Our Take

Last month, Wells Fargo reported its first quarter earnings results. The company’s first quarter 2012 earnings of 75 cents per share were 2 cents ahead of the Zacks Consensus Estimate. Results improved both sequentially and year over year. Results were primarily driven by a higher top line.

We believe that over the long term, investors should not be disappointed with their investments in Wells Fargo given its diverse geographic and business mix that enable it to sustain consistent earnings growth.

Going forward, we believe that strategic acquisitions will expand Wells Fargo’s business and improve its profitability. In fact, Wells Fargo’s growth plans have historically included a large number of acquisitions, Wachovia being the largest in December 2008.

We believe that long-term investors, who can absorb the risks related to economy and regulations, can expect decent growth in Wells Fargo’s earnings in the future. Solid capital levels, expense management as well as improved credit quality will also support its profit figures.

Notably, Wells Fargo passed the stress test of the Federal Reserve with flying colors in March. Following the approval of the capital plan by the Federal Reserve, Wells Fargo has hiked its dividend by 10 cents to 22 cents per share.

Wells Fargo’s capital plan also includes an increase in share repurchase activity in 2012 compared with the prior year. It also incorporates selective redemptions of trust preferred securities that no longer count as Tier 1 Capital under the Dodd-Frank Act. Such efforts have a positive impact on the stock price.

Yet we believe the top-line headwinds will persist, given the protracted economic recovery. Plus, a low interest rate environment would keep its margins under pressure. Wells Fargo’s unrelenting legacy mortgage issues also remain a concern. With the thrust of new banking regulations, there will be pressure on fees, and loan growth could remain feeble.

According to the Zacks Consensus Estimate, Wells Fargo is currently expected to report earnings of 81 cents per share in the second quarter of 2012, representing around a 16% increase year over year. For 2012, the company is likely to report earnings of $3.27 per share, also 16% above the reported figure for 2011.

Wells Fargo currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term Neutral recommendation on the stock.

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