Value Investors Tribe

Analysis Date: March, 2023

For the analysis of any business, I use the framework described by Warren Buffett in 2007 letter to shareholders. Warren Buffett looks for four parameters particularly: a) Understandable business economics b) Long-term growth prospects c) Able and trustworthy management d) A sensible price tag.

Business Economics and its Moat

US Bancorp is one of the oldest banks in US and was established in 1863. Being in the business for over a century provides a competitive edge, especially in banking business, since the institution has witnessed several economic cycles and was successfully able to navigate it. The Company provides a full range of financial services which a typical bank provides. Banking business is relatively easy to understand; banks usually borrow money from federal government and other sources at x% and lends it in forms of loans to the market at y%. This difference i.e. y%-x% is what the bank earns and is termed as Net Interest Margin (NIM). For instance, if a bank borrows money at 2% and distributes loans at 5%, bank earns 3% (5%-2%) as its income or NIM. In addition to these banks also earn on several fixed fees as a part of transaction. Two of the biggest moats in any bank is customer trustworthiness and disciplined capital allocation. This is because with customer trust, a bank would be able to raise funds via deposits which can be distributed as loans. Having a disciplined capital allocation will allow the bank to earn interest via NIM and the cycle continues. This eventually creates a compounding machine which is easy to understand however extremely difficult to replicate and hence becomes a competitive advantage.

US Bancorp checks both these parameters. In 2014 end, bank had total deposits of $283 billion which grew to $512 billion by 2023 end, this represents compounded growth of about 7% compared to 5% average growth for banking industry. This represents significant customer trust in US Bancorp despite the bank not being in top three banks of the US. In terms of capital allocation discipline, US Bancorp has historically maintained healthy mix of lending i.e. providing loans in different sectors which reduces risk by diversification. By the last quarter of 2023, of the total loans distributed, there were 35% commercial loans, 14% commercial real estate loans, 31% residential mortgages loans, 8% credit card loans and 12% other retail loans. US Bancorp understands that in banking businesses, slow and disciplined growth while maintaining customer trust is the secret sauce to success.   

Growth Prospects

US Bank is highly active in 26 states of US and in 2023, the company offered services in all 50 states for clients and non-clients to open certificate of deposits (CDs) in all 50 states even though a local branch is not present. Over time, as the bank starts operations with starting local branches in those states, the growth is inevitable as the customer trust comes into play. Additionally, at present the fee revenue which are fixed fees mostly represents over one third of the total revenue which acts as a stable and sustainable source of income which will grow as bank expands its operations in different states. Additionally, the bank has invested significantly in technology to make customer experience smooth and leverage technology to grow as well as has done acquisitions to grow the business. Historically, return on equity has been about 13%-15% and return on assets has been about 1%-1.5% which indicates profitable growth. Dividends has grown by about 8% on compounded basis over the last 10 years which indicates stability along with the growth. Combination of all these factors indicate not exponential but healthy growth for US Bancorp in future.  

Management Trustworthiness

Andrew Cecere serves as CEO, President and Chairman of US Bancorp and has been with the bank for over two decades, serving in different roles. Management is candid with the shareholders and makes good attempt at explaining intricacies of banking. US Bancorp shares all the data necessary for an individual to understand the business and has been doing since a long period of time. The Board of Directors is diverse with good amount of experience in banking industry.

Valuation

To value US Bancorp, a DCF analysis is done since it is relatively easy to predict future cash flows of the bank given its historical data. Historically, for the past ten years (2012-2022), revenues have grown at compounded annual rate of 2% with net earnings growth of 1% and Free Cash Flow growth of 13%. Given that bank is a cyclical business, there are wide anomalies in conventional metrics as expected. A consistent figure to track is loan book growth and for the past ten years, loan book has grown at about 6%. In 2022, there was unusual bump in free cash flow and so for 2023, free cash flow degrowth of 25% and for 2024 and 2025, degrowth of 35% is assumed with 4% growth in subsequent years. With these assumptions, DCF is shown below with discount rate of 8% and terminal growth rate of 2%

• Sum of Present Value of FCF (million $): 49688.2
• Terminal Value (million $): 117653.0
• Present Value of Terminal Value (million $): 54496.1
• Total Equity (million $): 104184.3
• Shares Outstanding (millions): 1558.1                                                                                                                         
• Intrinsic Value (per share): $67
• Current Trading Price: $42
• Margin of Safety: 37%

What does this mean? Based on the rough estimates of cash business is expected to generate, intrinsic value of US Bancorp is $67 per share. Additionally, US Bancorp has repurchased shares in December 2023 at an average price of $45.31 per share.

Disclaimer: This fundamental analysis of US Bancorp is primarily for educational purposes so as to help value investors learn core concepts. This is not a buy or sell recommendation of any form whatsoever. Reader discretion is advised.