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Wells Fargo: An Attractive Dividend Opportunity

Eric Compton

Eric Compton: Wide-moat-rated Wells Fargo is still trading within a 4-star range, and the bank boasts one of the top dividend yields among our coverage, at roughly 3.8%. Unfortunately, the Wells Fargo name has become synonymous with "scandal," and the bank is now in year three of "surely we will fix this soon," resulting in years of disappointments for shareholders. 

The bank does face real issues, including current and future potential impairments to its brand, which is already making it difficult to stem the loss of future business, such as from advisors or retail customers who have lost faith in the bank, and the bank will likely remain under its asset cap through the end of 2019. 

Initially, the bank had found ways to maneuver the balance sheet to make the asset cap sting as little as possible, but with those efforts already largely completed, the bank will face a higher cost from being unable to grow. The constant focus on defense has also robbed the bank of an ability to be more aggressive on offense during a time when the banking industry is arguably changing faster than ever. 

While the negatives are obvious, they are also being priced into the stock to some degree, giving investors, particularly those searching for yield, a potentially attractive opportunity.

We will highlight that Wells is still very profitable, yielding a return on average tangible equity of over 15% in the most recent quarterly results. With an inability to invest in balance sheet growth, the bank will be more focused on share repurchases and dividend growth than most of its peers. Further, with a current CET1 ratio of 11.7%, compared to an internal target of 10%, the bank also has more excess capital than most peers. The combination of the asset cap and excess capital should lead to healthy dividend and share repurchases in 2019. 

While the asset cap will eventually be lifted, we think when that does happen, and if Wells can maintain or even improve their current returns, shareholders should eventually be rewarded with share price appreciation. 

In the meantime, the bank may be able to repurchase roughly 6% of shares in 2019 and roughly 5% of shares in 2020, subject to regulatory approvals, and with the share counts declining, we forecast the bank could support dividend growth in the double-digit range over the next several years, even with limited top-line revenue growth. This should provide some cushion for shares as the bank continues to navigate the real risks and issues it faces over the next several years.