We are downgrading our recommendation on U.S. Bancorp (USB) to Neutral from Outperform based on a stretched operating environment which is likely to temper its growth momentum in the quarters ahead.
While U.S. Bancorp has a solid franchise and diverse revenue stream, we believe that a tepid economic recovery, regulatory issues along with the expected continued low interest rate environment are projected to limit the stock's upside potential in the upcoming quarters.
A sluggish economy that adversely affected consumer and business spending has impacted a number of fee-based categories of U.S. Bancorp over the last several quarters. Though we expect the fee-based category to improve over time with a step-up in the economy, we think that the progress will be tardy with the economy recovering sluggishly.
U.S. Bancorp is expected to experience a growth in loans in 2012. But given the company's cash position and the current low interest rate environment, which is anticipated to continue in the next several quarters, we foresee net interest margins being under pressure going forward.
Moreover, as a result of the latest regulatory reform, we expect the company to be subject to both top- and bottom-line headwinds. Stricter capital requirements are also likely limit the company's flexibility with respect to business investments.
Yet, U.S. Bancorp has weathered the financial crisis well and remains one of the most profitable large-cap banks in the industry. In April, U.S. Bancorp reported first-quarter 2012 earnings of 67 cents per share, beating the Zacks Consensus Estimate by 3 cents. Results were driven by year-over-year growth in revenue, supported by increases in net interest income as well as fee-based revenue, and reduced credit costs.
U.S. Bancorp's strong retail banking franchise and leadership in payment processing should continue to create growth opportunities. The company is also focused on expanding its business through acquisitions.
U.S. Bancorp has a disciplined approach to capital management and capital redeployment remains a top priority. The stress test clearance along with the capital redeployment plans justifies the company's solid capital position.
After receiving the approval from the Federal Reserve, the company has hiked its dividend by 56% and announced a 100 million-share repurchase authorization. Such shareholder-friendly approach inspires investors' confidence in the stock.
Moreover, U.S. Bancorp is experiencing improvement in its credit quality with a drop in nonperforming assets, charge-offs and provisions for loan losses.
Therefore, the risk-reward profile of U.S. Bancorp seems somewhat balanced and we have assigned a Neutral recommendation on the stock. Additionally, U.S. Bancorp shares currently retain the Zacks #3 Rank, which translates to a short-term Hold rating. One of its closest peers, Wells Fargo & Company (WFC) also retains a Zacks #3 Rank.
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