Wells Fargo is flat after an earnings beat — here’s why and our outlook on shares

Wells Fargo reported better-than-expected earnings results on Friday, but some weakness under the hood is putting a lid on the bank’s stock. Stay the course: Shares should move higher as management continues to shake off regulatory punishments for past misdeeds. Total revenue for the three months ended Mar. 31 ticked up less than 1% over last year, to $20.86 billion, exceeding analysts’ expectations of $20.2 billion, according to LSEG. Adjusted earnings of $1.26 per share was nicely above Wall Street’s consensus estimate of $1.11 per share, LSEG data showed. Note: The $1.26 EPS excludes a 6-cent per share ($284 million hit to net income) negative impact from a Federal Deposit Insurance Corporation (FDIC) special assessment for the rescue of regional banks after last year’s failure of Silicon Valley Bank. This special assessment charge was a 40-cent per share headwind in the fourth quarter of 2023. 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 results skew positive, even with some key line-item misses. For one, the bank’s overall efficiency ratio was a tad higher than expected. (The ratio is non-interest expense divided by total revenue, the lower the ratio the better the efficiency). However, we expect to see that number come down over time as management continues to address regulatory concerns and makes progress toward the ultimate removal of the asset cap. In addition, the bank’s net interest margin came up short, and therefore net interest income. We aren’t too surprised given that interest rates are a double-edged sword for banks. Higher rates mean higher revenue generation on loans; they also mean higher funding costs (interest payments on deposits) as customers withdraw deposits in search of higher yields elsewhere. None of this is news: We’ve seen this dynamic play out for several quarters already. That said, in general, higher rates are a net positive for Wells Fargo’s bottom line. Many positives outweighed the negatives. For example, non-interest expenses increased this quarter to a level above Street estimates, but non-interest income advanced at a faster rate and ahead of expectations. Likewise, the bank’s tangible book value per share came in a bit soft but was more than offset by better-than-expected return on tangible common equity performance — a key metric that investors take into heavy consideration when determining the appropriate valuation multiple to place on a bank’s stock. Also a plus: The bank’s provisions for credit losses were much lower than expected. That’s especially good considering the concerns many had regarding Wells Fargo’s commercial real estate exposure and increased credit usage by consumers as their pandemic savings diminished. On the post-earnings call with investors, CEO Charles Scharf said: “We continue to see strength in the U.S. economy, spending patterns of consumers using our debit and credit cards remain generally consistent and continued to grow year over year. Consumer credit is performing as we expect, wholesale credit continues to perform well, and our views around commercial real estate have not significantly changed since last quarter.” On the capital return front, we got a big step up in returns to shareholders, with the bank repurchasing $6.1 billion worth of stock (112.5 million shares) in the first quarter. That’s a major increase from the $2.4 billion (51.7 million shares) repurchased in the fourth quarter. Moreover, despite the CET 1 ratio — which compares a bank’s capital against its risk-weighted assets — coming in a tick below expectations, it’s nothing to be concerned about. There’s plenty of excess capital left for management to return to shareholders. Wells Fargo is on the right path to increasing efficiencies, driving ROTCE (return on average tangible common shareholders’ equity) toward management’s goal of 15%, and having its regulator-imposed asset cap removed. As a result, we are increasing our price target on WFC shares to $62 from $60, but maintaining our 2 rating as we look for a better entry point. WFC YTD mountain Wells Fargo YTD Guidance Wells Fargo’s management team maintained its outlook for full-year 2024 net interest income: 7% to 9% lower than the $52.4 billion level achieved in 2023. This implies a range of $47.7 billion to $48.7 billion, a miss versus the $48.8 billion consensus estimate coming into the print. We don’t like a miss on guidance. However, bank interest income estimates depend on interest rates, a factor Wells can’t control. Management said on Tuesday that it’s still early in the year and ultimately “the amount of net interest income we earn will depend on a variety of factors, many of which are uncertain, including deposit balances mix and pricing, the absolute level of interest rates and the shape of the yield curve and loan demand.” Keep in mind that management has been very focused on decreasing the revenue contribution from interest-based revenues, focusing instead on growing the non-interest, fee-based revenues, a move we strongly support as it serves to reduce volatility and reliance on interest rate dynamics that management can’t control. “We’re beginning to see early signs of share and fee growth which will be important as we diversify our revenues and reduce net interest income as a percentage of revenue,” the company said. Full-year non-interest expense guidance was also left unchanged at roughly $52.6 billion. That’s a bit below the $52.95 billion expected, which is a positive. First-quarter results Consumer banking and lending revenue fell nearly 3% year over year to $9.09 billion. Consumer and small business banking (CSBB) revenue fell 4% as the tailwind of higher debit card fees was more than offset by lower deposit balances. Within consumer lending, home lending was flat versus last year and up 3% sequentially. Credit card revenue increased 6% annually and 3% on a sequential basis. Auto loan revenue was down 23% year over year and down 10% sequentially. Personal lending increased 7% from last year but declined 1% sequentially. Commercial banking revenue fell 5% to $3.15 billion. Middle-market banking revenue declined 4% year over year, while asset-based lending and leasing revenue was down 7% annually. Non-interest expenses fell 4% due to a reduction in personnel expenses and efficiency gains. Corporate and investment banking revenue increased nearly 2% to $4.98 billion. Total banking revenue increased 5% year over year, as a 3% decline in lending and a 13% decline in treasury management and payments revenues were more than offset by a 69% increase in investment banking revenues. Commercial real estate revenue fell 7% as the headwind of lower loan balances was only partially offset by increased commercial mortgage-backed securities volumes. Markets revenue was up 2% on the back of a 6% increase in fixed income, currencies, and commodities (FICC) revenue, and a 3% increase in equities revenues. Non-interest expenses increased 5% annually, due to higher operating costs, which were only partially offset by efficiency gains. Wealth and investment management revenue advanced about 2% to $3.74 billion. Net interest income fell 17% year over year as deposits declined due to customers reallocating cash into higher-yielding securities. Non-interest income increased 9% thanks to higher asset-based fees driven by an increase in market valuations. Non-interest expenses were up 6% annually as higher revenue-related compensation was only partially offset by 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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