US Bancorp Without Much Upside

Despite concerns of liquidity and continued turmoil in the credit markets, U.S. Bancorp’s (USB) core second-quarter results were slightly ahead of our expectations, driven by an increase in net interest income. The improvement stemmed from growth in higher spread assets and benefited from a liability sensitive balance sheet in a declining rate environment. While we are encouraged to see diversified revenue source, we remain wary of growing credit and margin pressures.

The credit quality has worsened and the company has substantially increased its loan provisions. We reiterate our Hold rating on the shares of USB, but moderate our 2008 and 2009 earnings expectations to $2.35 per share and $2.45 per share, respectively. We think the uncertainties for this company as well as the industry, competitive market conditions and credit quality deterioration potential should continue to weigh upon the shares of USB in 2008 and into 2009.

USB currently trades at 14.4 times the consensus forward estimate. On a price-to-book basis, the shares trade at a 211% premium to the peer median. Relative pricing currently looks attractive on a P/E-to-growth basis, using the consensus forward estimate and the consensus long-term growth rate. Our new six-month price target of $35 equates to approximately 2.93 times our projected book value six-months out, or 14.9 times our 2008 earnings estimate of $2.35 per share. We view the $1.70 per share annual dividend as secure, implying a 6.6% expected total return over that period.

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