U.S. Bancorp stock (NYSE: USB), a leading bank with close to $550 billion in assets, gained roughly 23% – increasing from about $47 at the beginning of 2020 to around $57 currently, outperforming the S&P500, which grew 20% over the same period.
There were three clear reasons for this: First, the U.S. government’s approval of the $1.9 trillion coronavirus relief package in March. Second, the fast-paced Covid-19 vaccination drive in the country. Third, the Fed’s decision to keep the interest rates at current levels for some more time. All of the above factors give weight to the forecasts of a strong economic recovery.
But we believe there is more upside to come over the coming months
Trefis estimates U.S. Bancorp’s valuation to be around $63 per share – about 10% above the current market price – based on one key opportunity and one risk factor.
The opportunity we see is U.S. Bancorp Revenues growth over the subsequent quarters. USB is primarily a commercial bank, with income from loans and other core banking products constituting most of its top-line. It reported revenues of $23.2 billion in 2020, which was marginally above the 2019 figure. This was primarily driven by a 6% y-o-y growth in the non-interest income, partially offset by a slight decline in the net interest income (NII) – the bank generates close to 55% of its revenues from net interest income. The drop in NII was mainly due to interest rate headwinds and lower outstanding loan balances, which continued in the first quarter of 2021, also.
The bank recently released its second-quarter 2021 results, with revenues and earnings beating the consensus estimates. It reported total revenues of $5.76 billion – down 1% y-o-y, as the wholesale banking revenues dropped 23% y-o-y followed by a 3% drop in consumer banking. However, the negative effect was offset by a 19% y-o-y jump in the payment services unit. Notably, the NII maintained its negative growth trajectory in the second quarter, too. On the flip side, the bank reduced its provisions for credit losses from $1.7 billion in Q2 2020 to -$170 million in the quarter, benefiting its profitability numbers.
U.S. Bancorp’s net income margin is expected to improve in 2021. The bank is likely to see some improvement in its card and payment transaction volumes driven by a recovery in consumer spending levels. Further, the lower interest rate environment will likely hurt the NII, partially offset by some growth in outstanding loan balances. Overall, it is likely to result in an EPS of $4.54, which coupled with the P/E multiple of just below 14x will lead to a valuation of around $63.
Finally, how much should the market pay per dollar of U.S. Bancorp’s earnings? Well, to earn close to $4.54 per year from a bank, you’d have to deposit about $454 in a savings account today, so about 100x the desired earnings. At U.S. Bancorp’s current share price of roughly $57, we are talking about a P/E multiple of just below 13x. And we think a figure close to 14x is appropriate.
That said, banking is a risky business right now. Growth looks less promising in core banking, and near-term prospects are less than rosy. What’s behind that?
U.S. Bancorp has a sizable loan portfolio of $297 billion (as per June 2021 data). This makes the bank very sensitive to change in interest rates. The loan default risk increased in 2020 due to the Covid-19 crisis. Hence, the bank increased its provisions for credit losses from $1.5 billion to $3.8 billion. While the provisions figure has decreased over the recent quarters, suggesting some improvement in the economy, any sudden rise in the Covid-19 cases or worsening of the economic conditions can expose USB to substantial loan defaults. Further, the lower interest rates will likely hurt the net interest margin (NIM) of the bank, negatively impacting the NII. To sum things up, we believe that U.S. Bancorp stock has limited upside.
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