U.S. Bancorp: Don't Forget About This Fair Valued Bank
If you were to survey the field to name major banks, we're guessing that U.S. Bancorp (USB) wouldn't top too many lists. Instead, the likes of J.P. Morgan (JPM), Wells Fargo (WFC), Bank of America (BAC) or Citigroup (C) would probably come to mind. Yet with $361 billion in assets, the Minneapolis based U.S. Bank holding company comes in as the 5th largest commercial bank in the United States. It operates over 3,000 banking offices with nearly 5,000 ATMs in 25 states - providing banking, brokerage, insurance, investment and payment services to consumers, businesses and institutions.
If you were to ask Warren Buffett what his favorite bank was, Wells Fargo - making up over $20 billion of Berkshire Hathaway's (BRK.A) investment portfolio - would likely be named. Yet what's not readily apparent is that his second favorite bank might very well be USB. Buffett's Berkshire Hathaway currently owns 96 million shares or just over 5% of the entire business - a number that's been climbing since 2006.
Even Jim Cramer recently came to USB's defense in a recent episode of his CNBC show:
"[U.S. Bancorp is] a personal favorite of mine... ever notice how you never hear about these guys getting in trouble? That's because they don't."
This thought is seemingly echoed by Morningstar analyst Dan Werner:
"There are few domestic banks that can match the operating performance of U.S. Bancorp since the financial turmoil of 2008-09. U.S. Bancorp's longstanding ability to post excess returns on capital is rooted in its superior credit underwriting, fee generation, strategically beneficial acquisitions, and sound management. As with any high-quality bank, strong loan underwriting is fundamental. Even at the height of the financial crisis, U.S. Bancorp never incurred a loss from severe credit charge-offs as seen at other institutions."
Of course it is true that banks as a whole might not have the same return patterns as they had before the financial crisis - U.S. Bancorp has indeed seen lower return on assets and equity than it had before 2008. Yet the company still has the ability to generate meaningful and increasing profits. Among banks, it's still leading in the return ratio categories and also has the highest debt rating to boot. Further, in the Federal Reserve's most recent Comprehensive Capital Analysis and Review, U.S. Bancorp was approved to increase its dividend by 6.5% and buy back an additional $2.3 billion in stock. Should another crisis come along, it appears that U.S. Bancorp is here to weather that storm.
With that, we thought it might be interesting to review the company's past operating history and potential prospects moving forward. Below we have included the Earnings and Price Correlated F.A.S.T. Graph for U.S. Bancorp. Here you can immediately see that the financial crisis impacted earnings, but the bank remained largely profitable during this time. Further, notice that the dividend payout was forcibly cut in 2009, yet the company has easily covered these payouts (even more so than before the recession) in the years that followed.
If we add price to the equation, we can see that where earnings go, price eventually follows. In the case of U.S. Bancorp, this is especially apparent. At the beginning of this period shares traded at roughly 14 times earnings as compared to about 13 times earnings today. In the decade and a half between, U.S. Bancorp's share price more or less followed earnings neatly to come to a "normal" P/E ratio of about 13 and a half. Additionally, note that earnings grew by almost 5% per year during this period despite the financial "collapse" in the middle.
If you add in the performance results, the picture gets even more interesting. Had you gone back in time and forewarned potential investors that a financial crisis was coming, logic would tell you that the last place one might want to be invested would be in a bank. Yet take a look at what happened since 2001. A hypothetical $10,000 investment would now be worth about $17,000. In addition, you would have received roughly $5,000 in total dividends for an annualized return of just over 6%. Expressed differently, the U.S. Bancorp investor - despite the financial collapse - would have both achieved results that beat the S&P Index by a couple of percentage points and receive an "extra" $3,000 in dividend payments as well. There's something to be said for a strong and enduring business model - no matter how high or low the intermediate peaks and valleys.
But of course one cannot invest in the past. Instead, a potential investor should be aware of a company's history while simultaneously focusing on the future prospects. One thing that has been relatively consistent in U.S. Bancorp's past is its desire to return capital to investors. True the recession caused the dividend to be slashed dramatically, but before, and now after the fact, dividends and share repurchases have been strong.
US Bancorp Chairman and CEO - Richard Davis - had this to say in the last quarterly earnings call:
"We've said for as long as I can remember that we would return 30% to 40% of our earnings in the form of dividends and 30% to 40% in the form of buybacks. [For] 2013, the full year was 71%, the quarter was 65%, and so we're in that low level range."
On the share repurchase front, management has used 12%, 35% and 42% of the total earnings to retire common shares in the years 2011, 2012 and 2013 respectively. It might not seem like buybacks do much, but if used appropriately they can have lasting effects. For instance, moving from 2012 to 2013, total net income grew by 3.3% while diluted EPS grew by 5.6%. Here's a look at the company's common shares outstanding in over the past decade:
On the dividend front it appears that there is still more room to increase payouts. For the 2010 - 2014 periods the dividend payout ratios were 11%, 20%, 27% and 29% - not yet reaching management's long-term target. If you take this information collectively, you find that shares of U.S. Bancorp are trading in line with its historical level, have the ability to increase dividends at a slightly faster pace than earnings and could see reasonable EPS growth as well.
Below we have expressed that information in a picture by using the Estimated Earnings and Return Calculator. Up to 27 analysts come to a consensus median long-term growth rate estimate of 6.6%. This coupled with the next few years of precise earnings and dividend forecasts appear reasonable when compared to other sources. If these estimates come to fruition - and U.S. Bancorp traded at a 15 P/E multiple - this would indicate an 11.5% 5-year annualized total return.
Now, it's paramount to underscore that this is simply a calculator defaulting to analysts' median estimates. However, it does provide a solid baseline from which to begin judging a company. Overall we believe that U.S. Bancorp is a strong bank that has proven itself even during the worst financial crisis in memory. While it doesn't receive as much attention as some of the other banks, it appears just as interesting from an investment perspective. However, as always, we recommend the reader conduct his or her own thorough due diligence.
Disclosure: Long WFC, C at the time of writing.