4 U.S. Banks on Double-Digit Discounts

As the markets react to the U.S. elections, one of the industries watching the elections most keenly and closely is banking. The election results have clear implications for the U.S. banking sector, particularly with regards to regulatory changes, economic policies, the real estate market, and the pandemic management.

2019 was a bumper year for the sector, with the Morningstar US Financial Services index clocking a 30% return, but 2020 saw a reversal of fortunes. The financial services sector was one of the hardest hit this year, down nearly 18% for the year to date, as of Oct 29. For the same period, the Dow Jones U.S. Banks Index plummeted a staggering 37%, relative to the 1.25% gains for the S&P 500 index.

This has created some attractive investment opportunities for opportunistic long-term investors with some risk appetite. These U.S. bank stocks are trading at a sizeable discount to their intrinsic values offering some margin of safety. While not immune from economic and systemic disruptions caused by cataclysmic events of global scale, these are well-capitalized institutions able to withstand the financial fallout of the pandemic, a slow and protracted economic recovery, and the resultant low interest-rate environment.

One of the largest U.S. banks, Wells Fargo (WFC) runs community banking, wholesale banking, and wealth and investment management operations. It boasts approximately US$1.9 trillion in balance sheet assets. Wells Fargo has the largest retail branch network in the U.S. and is one of the largest U.S. issuers of credit and debit cards.

Despite past missteps and years of negative headlines, Wells Fargo remains one of the top deposit gatherers in the U.S. “Its strategy historically rested on deep customer relationships, sound risk management, and operational excellence,” says a Morningstar equity report, noting “while the operational excellence has been questionable of late, the bank has easily outearned its cost of equity for decades and continues to do so today.”

Owing to its robust U.S. branch network, the bank “excels in the middle-market commercial space, has a strong advisory network, and as a result has generally generated more revenue per dollar of assets than most peers over time,” concedes Morningstar equity analyst, Eric Compton, stressing “the bank has an attractive lineup of business units and a core group of loyal, longtime customers.” Prompted by the wide-moat bank’s recent quarterly report, marked by disappointing net interest income, Compton lowered the stock’s fair value from US$46 to US$45.

A diversified financial-services provider, U.S. Bancorp (USB) is America’s fifth- largest bank with branches across 20 states. The bank’s services include retail banking, commercial banking, trust and wealth services, credit cards, mortgages, and other payments capabilities.

“U.S. Bancorp is one of the strongest and best-run regional banks we cover,” says a Morningstar equity report, noting “few domestic competitors can match its operating efficiency.”

For the past 15 years, it adds, the bank’s returns on equity have outpaced those of its peers and its own cost of equity. The lender has an attractive mix of fee-generating businesses, including payments, corporate trust, investment management, and mortgage banking. “U.S. Bancorp’s exposure to moaty nonbank businesses and its consistently excellent core banking operations make us like the company's positioning for the future,” says Compton, who recently upped the stock's fair value to from US$45 to US$48.

The bank’s sizeable investment in technology has positioned it well to benefit from emerging industry trends. “The continued secular trend of the increasing digitization of payments should provide further growth opportunities, and the importance of scale and technology should favour the largest banks, including U.S. Bancorp, over time,” says Compton.

Global investment banking giant, Goldman Sachs (GS) offers services in investment banking (20% revenue), global markets (40%), asset management (25%), and consumer and wealth management (15%) segments. The Americas account for nearly 60% of its revenue, Asia another 15%, while 25% comes from Europe, the Middle East, and Africa.

At the end of 2019, Goldman had US$1.9 trillion of assets under supervision, of which approximately 10% were in alternative investments, 25% in equities, 40% in fixed income, and 25% in liquidity products. “While brokerage and principal investing are competitive businesses, Goldman Sachs is arguably the best in the business with a history of strong growth and returns partially attributable to its informational advantages, technology infrastructure, and risk management,” says a Morningstar equity report, which assigns the firm a narrow economic moat.

Goldman Sachs laid out a strategic plan in early 2020 which includes a return on equity greater than 13% and a return on tangible equity greater than 14%. The plan “may be achievable, but the timing of its realization will be delayed by the coronavirus-induced global slowdown,” cautions Morningstar sector director, Michael Wong, who lowered to stock’s fair value from US$239 to US$238, prompted by regulatory fines related to 1MDB. 

Global banking behemoth, Citigroup (C) offers financial services in more than 100 countries. The firm’s primary businesses include the global consumer banking segment, which provides basic branch banking around the world, and the institutional clients group, which comprises investment banking, cash management, among other products and services.

“Citigroup's truly global presence differentiates the bank from all of its U.S.-based peers,” says a Morningstar equity report, pointing out the lender generates significant revenue from Latin America and Asia, and that it’s “poised to ride the growth of these economies through the coming decade.”

“Citigroup investors should be able to sleep more soundly over the next decade, and if the bank proves it can handle a downturn, shareholders should be rewarded,” says Compton. The bank’s recent performance has been impacted by the Covid-19 fallout with quarterly revenue down 7% year over year, and net interest income falling 10%, which prompted Compton to decrease the stock's fair value from US$71 to US$68.