Published March 5th, 2017 by Bob Ciura
Bank stocks have been in rally mode since the November elections. This has made Warren Buffett even richer than he was before.
Berkshire Hathaway (BRK-A) holds several bank stocks in its massive, $148 billion portfolio, led by U.S. Bancorp (USB)
With 85 million shares, Berkshire is U.S. Bancorp’s second-largest investor. Berkshire owns 5% of the company, in a stake worth approximately $4.3 billion.
Banks have seen their valuations rise considerably in just the past few months, as investors become more comfortable with the outlook for the financial sector.
This article will discuss why Buffett has taken such a huge ownership stake in U.S. Bancorp.
The biggest reason why Warren Buffett owns U.S. Bancorp is likely because of its strong management team and competitive advantages.
Last year was a record one for U.S. Bancorp. Net income reached a record of $5.9 billion. Earnings-per-share of $3.24 was also a record performance.
Earnings-per-share rose 2.5% for the year.
The company experienced growth across most of its key metrics.
Source: 2016 Earnings Presentation, page 5
As the U.S. economy continues to steadily recover from the Great Recession, consumers are becoming more financially healthy.
This has resulted in accelerating growth in both loans and deposits over the past several quarters.
Source: 2016 Earnings Presentation, page 6
Average loans and deposits increased 6.9% and 8.9% last year, respectively, from 2015.
In addition, the company is seeing strong growth in financial and investment fees. Last quarter, trust and investment management increased 9.5%, along with 13.7% growth in mortgage banking.
One of the major growth catalysts for banks is rising interest rates. Higher interest rates helps boost investment income that banks earn.
When interest rates go up, U.S. Bancorp will see its interest earned on long-term loans rise at a faster rate than growth in interest paid on its deposits.
This has already started to materialize, since the Federal Reserve started raising interest rates last year. For example, U.S. Bancorp’s net interest income rose 4.6% in 2016.
Source: 2016 Earnings Presentation, page 10
Interest income would be a huge catalyst, since it makes up more than half of the company’s annual revenue.
Moreover, higher interest rates are often an indication of an improving national economy.
As unemployment falls and the economy grows, U.S. Bancorp will benefit from continued improvement in its credit portfolio.
Source: 2016 Earnings Presentation, page 17
Last year, the company’s core commercial loan portfolio experienced rising loans with falling charge-offs and delinquency rates.
Competitive Advantages & Recession Performance
The main competitive advantage for U.S. Bancorp is the iron-clad grip it has on its core services. As a regional bank, U.S. Bancorp has focused itself on a particular region of the U.S.
U.S. Bancorp ended 2016 with $446 billion in assets, making it the-fifth largest commercial bank in the country. It has more than 3,100 banking offices and more than 4,000 ATMs.
It provides a full suite of financial services, including banking, investment, mortgage, trust, and payment services, which it offers to both consumers and businesses.
U.S. Bancorp is not a major player in investment banking or trading. Instead, it has a strong grip on its niche, which is consumer and small business banking.
Source: BancAnalysts Association of Boston Conference, page 6
Its expansive footprint across its targeted region provides the company with great name recognition and brand equity.
These qualities allowed it to remain steadily profitable, even during the depths of the Great Recession:
- 2007 earnings-per-share of $2.43
- 2008 earnings-per-share of $1.61
- 2009 earnings-per-share of $0.97
- 2010 earnings-per-share of $1.73
- 2011 earnings-per-share of $2.46
While U.S. Bancorp suffered a significant decline in earnings-per-share from 2007-2009, it quickly recovered. By 2011, it had reclaimed all the ground it had lost from 2007, and then some.
U.S. Bancorp does not have an excellent dividend track record. In 2009, like many other banks, it cut its dividend.
And, it was a massive reduction—the financial crisis caused the company to slash its dividend by 88%. Fortunately, U.S. Bancorp resumed dividend increases once the recession ended.
However, even at its current level of $0.285 per share, U.S. Bancorp’s quarterly dividend is still not close to the $0.425 it was paying out in 2008.
Valuation & Expected Returns
U.S. Bancorp is a very solid company. But, its stock is not as attractive as it used to be. The shares have increased 23% just since November 8, the day after the election.
The reason for the sudden climb is that investors are anticipating higher interest rates, as the Fed is expected to raise interest rates as many as three times in 2017.
Plus, investors are anticipating a friendlier regulatory environment, including the possibility of deregulation policies put forth by the new administration.
In any case, U.S. Bancorp stock is now valued above historical norms. For example, at a price-to-earnings ratio of 17, the stock trades significantly above its average price-to-earnings ratio of 13 since 2000.
Buying now, at a higher price, has the effect of lowering U.S. Bancorp’s future expected returns.
A potential breakdown of U.S. Bancorp’s expected returns is as follows:
- 2%-4% revenue growth
- 1% margin expansion
- 1% earnings growth from share repurchases
- 2% dividend yield
As a result, U.S. Bancorp can be expected to generate 6%-8% annualized returns, plus or minus any changes in the price-to-earnings multiple.
U.S. Bancorp’s dividend yield is right on par with the average yield in the S&P 500. From an income perspective, it is about average.
That said, it has the potential for high dividend growth. The company’s rapidly improving financial performance has put it in a position to raise its dividend.
Last year, U.S. Bancorp delivered a solid 10% dividend increase.
Warren Buffett owns a number of bank stocks. One of its largest holdings is U.S. Bancorp, because of the company’s excellent reputation in the banking industry.
U.S. Bancorp struggled mightily during the Great Recession, but it has come a long way since the financial crisis.
The company is more profitable than ever, and is committed to returning its excess earnings to shareholders through dividends and share buybacks.
While this might not be a great time to buy the stock, due to its sharp rally in the past few months, U.S. Bancorp remains a best-in-class regional bank.