Jump Off the Wells Stagecoach
01/28/2008 12:00 am EST
Michael Shulman, editor of ChangeWave Shorts, says Wells Fargo makes a good short-sale candidate for investors who think financial stocks have more room to fall.
I have one more new short-side play for you: Wells Fargo (NYSE: WFC) is a great choice-and not just because of the subprime debacle.
Wells Fargo has 60% of its loans in traditional consumer sectors, according to Friedman Billings Ramsey (NYSE: FBR), and it is going to see negative growth in 2008 on an operating basis. Take a look at how it makes its profits (or hopes to):
1. Home and Mortgage Equity-19%
2. Consumer Finance-7%
3. Wholesale Banking/Commercial Real Estate-33%
If they're looking to the consumer to help them into recovery, they'd better think again. It's also worthy to note that the FBR analyst suggested that an even-greater percentage of WFC's revenues are consumer-driven (i.e., banking/credit card fees, service charges).
And since we're finding through our ChangeWave Alliance surveys that a number of folks are looking at paying down debt in 2008 with their discretionary dollars, no doubt that's going to take a bite out of WFC's revenues.
Better yet, let's look at [Wells's] $363-billion loan portfolio:
1. Real Estate (one- to four-family homes, primary mortgage)-18%
2. Real Estate (one- to four-family homes, secondary mortgage holder)-21%
3. Credit Card-5%
4. Revolving/Installment Loans-16%
5. Commercial Real Estate-9%
6. Construction Loans-5%
All of these categories hold loans that get riskier during a recession.
Over time, WFC will reveal more exposure to subprime, lousy credit cards, and terrible consumer debt-its figures will be smallish compared to most, but the problems are still there. This will force some write-downs and increases in loan-loss reserves.
But the real support for the WFC play is the end of the stock's growth story-the bank will hit a wall in 2008 and profits will slide, making the stock distinctly overvalued. The company also has very heavy exposure to the regions hit hardest by the housing downturn-California and the Sun Belt.
I like a short-side play in Wells Fargo for another reason: I have been looking for a fairly priced name in general consumer credit-and credit card debt-but premiums on puts for companies like Capital One are way too high to give us a significant-enough reward for our investment.
Not so for Wells Fargo-the puts are fairly priced and present a great opportunity: buy the Wells Fargo July 22.50 Puts (WFCSX) under $1.60. (They closed at around $0.90 while the stock closed below $31 Friday-Editor.)
(Editor's Note: Short selling is only for extremely risk-tolerant investors who can afford to lose the money they're putting up in these trades.)