Author: John Ingram

On 1/22/19, Travelers reported Q4 EPS of $2.13, slightly above consensus of $2.10. Catastrophic losses were elevated due to the devastating Camp Fire and Hurricane Michael. Excluding these losses, Traveler’s results improved year-over-year with the combined ratio falling 130bps to 91.1%. Travelers is a high quality, disciplined underwriter of insurance that is focused on returning capital to shareholders. TRV is selling at an attractive valuation of 11.4 x 2019 earnings.

Current Price: $127.16 Price Target: $145 (raised from $125)

Position Size: 2.19% TTM Performance: -5.8%

Thesis Intact. Key takeaways from the quarter:

1. Results were solid considering catastrophic losses
   • Solid premium growth 4% and retention rates of 87%
   • Investment income +15% with help from rising rates and lower taxes
   • Slight decrease in combined ratio to 91.1% due to improved results in autos and bond and specialty segments
   • 2018 ROE 10.7% up 170bps from 2017

2. TRV continues to aggressively return capital to shareholders – for 2018 TRV returned $2.1b to shareholders out of $2.4b in earnings
   • Over past 10 year shares outstanding have fallen 57%!
   • Shareholder yield of 6.2% which is a dip from +10% of prior quarters
   • Management employing capital wisely! Instead of investing in mature business with spotty pricing, they are returning excess capital to shareholders

3. Catastrophic losses have been elevated for past few years

Effective 2019, TRV significantly increased its catastrophe reinsurance, which should help smooth earnings and protect the balance sheet in the future.

4. Valuation is attractive. Currently TRV trades at a forward P/E of 11.4 which is close to the bottom of its five-year valuation range of 10 – 15.

The Thesis on TRV:

• We expect TRV will be able to grow book value per share in the mid-single digits over the near-medium term, and generate ROE in the 10-14% range
• Industry leader with disciplined underwriting and investment portfolio track record
• Consistent returns in the low to mid double digits
• Responsible capital allocation and proven desire to act in the best interests of shareholders

Thanks,

John

($TRV.US)

John R. Ingram CFA

Managing Director

Asset Allocation and Research

Direct: 617.226.0021

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

Last week, Wells Fargo (WFC) reported Q4 EPS of $1.21 roughly in-line with estimates. Earnings were pulled down a bit by the market’s Q4 weakness as was the case for peers. In the call, management pushed back the expected asset cap release date from mid-2019 to end of 2019. On the plus side, Wells continues to improve its culture and is aggressively buying shares, having reduced shares by 3% in the past quarter.

Current Price: $50.29 Price Target: $56

Position Size: 2.8% Trailing 12-month return: -20.7%

Highlights:

· Wells is a return of capital story with over $20b in excess capital.

o Dividend yield of 3.7% ~ 50 bips above peers

o Last quarter purchased 3% of shares spending $6.8B

o For 2018, WFC has a shareholder yield of 9.7% (3.2% dividend and 6.5% share buyback)

• Ongoing transformation of culture – Wells has made a lot of progress
  • Replaced former Chairman, John Stumpf with CEO, Tim Sloan, and added CFO Elizabeth Duke, a former Fed member, as independent chairman.
  • Named 6 new independent directors
  • Expecting the Federal Reserve to lift balance sheet asset cap restriction at end of 2019
  • On 4/20/18 Wells reported a $1b settlement with OCC and CFPD relating to forced car insurance and mortgage fees.
  • Recent moves to improve firm’s standing with employees
    • Increased base minimum hourly wage to $15.00 an increase of 11%
    • Increased 401k and profit sharing programs
    • Increased stock incentive compensation
  • Recent improvements to help customers
    • Overdraft rewind, zero-balance alerts, debit card on/off capability, and P2P payments
  • Wells still needs to settle with DOJ over residential mortgage policies dating back to the financial crises. Estimates place the settlement at $2b, but Wells has already set aside reserves of $3.2b
  • Additional lawsuits exist for overdraft fees, foreign exchange, mortgage fees, improper account closing and other smaller suits. Wells is not out of the woods, yet.
  • Plans to spend 2% of earning to philanthropy (up from 1.3%)
• Strong capital position
  • Common Equity Tier 1 Ratio of 11.7%
  • ROE 12.9% (Return on tangible equity 15.4%)
  • Returned $8.8b to shareholders through dividends and share repurchases for a shareholder yield of over 6.3%!
  • Solid credit quality – Nonperforming assets down from $8.3b in 4Q17 to $7.0b in 4Q18 as company continues to improve the balance sheet.
• Operational results
  • Noninterest revenue down -14% YoY hurt by Q4 market downturn and weak results in mortgage banking. Quarter results showed modest gains from sale of securities.
  • Noninterest expense down -21% in good cost control. Wells expect costs to fall 11% over the next 2 years.
  • Net interest income up 3% YoY loans up $6.9b
    • Deposits down 3% yielding 55 bips with low beta (33) to rising rates
    • Net interest margin stable at 2.94%
• Valuation
  • Valuation is below 5-year average at 12.1 P/E and 1.3 P/B, having bounced off a 5-year low in December of 11 P/E and 1.2 P/B
  • Yield and share buybacks provide strong support

WFC Thesis

• Best franchise in banking due to disciplined loan writing and quality mortgage underwriting
• Large deposit base that provides low cost funding
• Strong capital ratios put WFC in a good position to be opportunistic, invest for the long-term and return capital to shareholders
• Company is working hard to improve culture and repair image

($WFC.US)

John R. Ingram CFA

Managing Director

Asset Allocation and Research

Direct: 617.226.0021

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com