Washington Federal: Undervalued And Due A Return To Pre-March Levels

Investment Thesis

Washington Federal's stock (NASDAQ:WAFD) was unfairly hit by the sector-wide regional banking sell-off earlier this year. WAFD is currently significantly undervalued, as the bank has strong financials and adequate capitalization, which should alleviate any lingering concerns on this specific bank's prospects. I believe its valuation metrics warrant a return to the higher price levels seen before the banking crisis.

Company Summary & Stock Performance

Washington Federal Inc. is the bank holding company for Washington Federal Bank, headquartered in Seattle, Washington, which has expanded through multiple mergers and acquisitions over the decades to serve a broad list of western states through 200+ bank branches. WAFD is a full-service consumer and commercial bank, engaging primarily in lending, depository, and insurance activities.

WAFD started the year in an encouraging fashion, with the stock up over 10% in the first couple of months, before being dragged down by the US regional banking crisis, which saw the failure of lenders such as Silicon Valley Bank (OTCPK:SIVBQ), primarily due to market fear on adequate capitalization and unrealized losses from securities on the balance sheet. These market-wide concerns battered WAFD's stock price from a year-to-date high of $37 down to $25. Since then, there is an emerging handful of solid banks which have struggled to regain their prior stock valuations and are trading at significantly discounted levels, with WAFD proving an ideal example of a long-term value play.

Demonstrated further below, WAFD has good capitalization, minimal balance sheet losses, and solid fundamentals that should pull their stock back up to pre-March levels. We can see the significant divergence in the chart below of WAFD vs. the S&P 500 Financials Index (S5FINL Index on Bloomberg). WAFD is down ~19% year-to-date, whilst the S5FINL Index is only down ~2% in the same period. I believe WAFB will narrow this divergence as their current valuation provides for an attractive entry.

Financials

The recent financial results tell a different (positive) story when compared to how the stock has performed in recent months. Looking at the trailing twelve months data by quarter, Net Interest Income has benefitted from the higher interest rate environment in the US, reaching $683.2 million in Q1 23 (TTM), up from $643.3 million in Q4 22 (TTM). Over the same comparison periods, Total Revenues jumped to $730.3 million from $700 million, and Net Income rose to $282.1 million from $256.6 million. Looking ahead, the consensus revenue estimate for the fiscal year ending Sept. 2023 is ~$750 million, which would represent a year-on-year growth of ~13%.

From a dividend perspective in the last 5 years, WAFD management have successfully been able to pay a consistent and rising dividend pay-out to shareholders, and in some cases have marginally exceeded the forecasted amounts, as per the Bloomberg Dividend Summary below. The stock also currently pays a respectable Indicated Annualized Dividend Yield of 3.68%. If financial results continue to trend upwards, we can expect the future dividend amounts to continue to trickle higher.

Despite these solid financial results, one of the main concerns during the banking stress was that regional banks were sitting on significant unrealized losses on their securities portfolios (Treasury, Agency, MBS) on the balance sheet. This is not the case for WAFD, reporting an insignificant net unrealized loss on their hold to maturity investments of only $35 million, whilst at the same time maintaining ~$3.5 billion of cash and equivalent securities.

Overall, these strong realized and forecasted financials should be paired with a significantly higher stock valuation, making this an enticing value play.

Capitalization

The other main concern for regional banks was adequate capitalization. Looking at the Bloomberg Relative Valuation screen and comparing with North American regional banking peers, we can see that WAFD is sitting in a favorable position from a balance sheet and capitalization perspective.

The Tangible Common Equity (TCE) Ratio is a measure of a bank's capital adequacy based on the physical assets it owns, excluding intangible assets like goodwill and intellectual property. According to Bloomberg, WAFD's TCE Ratio of 8.14% is currently higher than the peer median, indicating in relative terms that the bank holds less leverage and a larger amount of tangible equity compared to tangible assets.

The Texas Ratio is another key metric to assess a bank's financial position, in this case comparing the non-performing assets to the tangible common equity and loan loss reserves. In this case, a lower reading is favorable, with WAFD once more sitting in an advantageous position to its peers, with a Texas ratio of 2.48 versus the median of 3.04.

These capitalization metrics portray WAFD in a well-capitalized position and consequently undermine the stock's current low valuation versus the wider regional banking index.

Valuation

Looking at the valuation metrics relative to peers on Seeking Alpha, we can confirm WAFD's undervaluation and discount to the sector.

The Price-to-Earnings Ratio (GAAP TTM) currently sits 6.64, at discount of ~27% to the sector median. At the same time, the Price-to-Book Ratio (TTM) is 0.86, at a discount of ~16% to the sector median.

Based on Seeking Alpha data, WAFD's EPS estimate for FY 2023 is 3.95, which if we apply to the sector median P/E Ratio (GAAP FWD) of 9.28, we can calculate a target price of $36.66. This represents an uplift of ~35% from the latest price, which also corresponds with the price of the stock in February, just before the banking sell-off in March. I believe a return to this higher valuation is justified based on the financial and capitalization position assessed above.

Shareholder Trends

I keep a close eye on the shareholder buying and selling trends on the stock, from both an institutional and insider management perspective, in order to confirm that invested parties are maintaining a constructive and positive positioning.

Analyzing the Top 10 institutional shareholders, we can see major players such as BlackRock (~15% of shares outstanding) and Vanguard (~12%) increasing their stakes in the stock in recent quarters. If there were significant concerns on WAFD, there would have been a reduction in their positions, but the inverse seems to be taking place, implying these large scale buyers see good value in WAFD.

On the management side, we can also see a reinforcing positive picture on a year-to-date basis, as the majority of insider management transactions have been further purchases of their own stock, which often signals to the market that the executives believe that their company stock is currently undervalued and worth a long-term investment.

Looking at the underlying data, Net Buys represented ~417,000 worth of shares, whilst Net Sells were ~29,000 shares, indicating a bullish aggregate view that confirms my position on WAFD's good value for a long-term investment.

Sell-Side Forecasts

Whilst WAFD is a relatively under covered stock by the sell-side community, it is still worth getting a gauge of the analyst sentiment. 2 of the 3 surveyed analysts on Bloomberg have 12 month target prices for WAFD in the mid to high 30s, consistent with the valuation approach in the above text. This helps affirm my bullish sentiment on the stock.

Risks

Based on the above factors, the future looks positive for WAFD. However, it is important to highlight that the underperformance experienced earlier this year, primarily driven by sector-wide concerns and not bank-specific WAFD fundamentals could re-occur once more. Whilst US inflation is successfully trickling down, and the Federal Reserve has decided to temporarily pause interest rate hikes and see how the economic data pans out in coming months, the prospect for a period of prolonged economic slowdown and even recession is still a forefront concern for many investors and economists. A deteriorating macroeconomic environment could result in a negative impact on WAFD's financial position and in selling pressure on the stock.

In Conclusion

WAFD looks to be part of a group of fundamentally sound regional banks that has felt the widespread pain of the regional banking sell-off earlier this year and is yet to experience a stock price recovery. I believe a move back up in the direction of pre-crisis levels is overdue, especially when considering the recent positives that WAFD has in its financial results, capitalization metrics, relative valuation, and shareholder positioning.