U.S. Bancorp (USB) is one of the country’s largest banks, with a focus on business and consumer lending as well as payment services and wealth management, notes Bruce Kaser, editor of Cabot Undervalued Stocks Advisor.
Unlike its larger peers, it has essentially no investment banking or trading operations. When we purchased USB shares, they were out of favor as investors worried about a potential surge in credit losses due to the pandemic as well as weak earnings due to the low-interest-rate environment.
Our thesis on USB shares played out. Loan losses have remained small, such that the bank is now gradually releasing some of its vast credit reserves. Strong profits have helped add to its already-robust capital. The bank recently commenced a new $3 billion share buyback program.
We recently sold our USB shares at a healthy profit, partly on valuation and partly on fundamentals. The shares had reached our price target, which was set at about 2.4x tangible book value.
This is a premium valuation for any bank, even for one as high quality as U.S. Bancorp. The 12.8x earnings multiple was also full enough to support our exit. Further fundamental gains are likely to be steady but slow.
Credit and operating costs have little room for improvement. While an increase in interest rates would boost profits, the bank’s bloated deposit base won’t likely be matched by faster lending (common among all banks), weighing on its net interest margin.
The bank remains exceptionally well managed, has attractive payments, investment management and other services businesses and a dividend yield (2.8%) that is modestly above market. But, we saw the overall risk/return trade-off as unfavorable.
