The financial services industry is attempting to cope with the economic slowdown by applying a variety of techniques just to get them through FY13. The global economic recovery is expected to start shining by FY14 as analysts suggest that growth prospects appear strong. Such a recovery is likely to have a positive impact on the financial intermediation system through the simple logic of more financial activity in the economy. In order to profitably walk through FY13, many banks have adapted the strategy of expense cuts and reserve releases to produce earnings. Analysts have also shown considerable caution in taking these earnings as a positive note by raising questions about the sustainability of such strategies. Despite such concerns, some players in the U.S. banking industry seem to not only make it to the daily news but also provide a genuine profit making opportunity to equity investors. JPMorgan (NYSE:JPM) is one of these diversified financial companies as it is the largest bank in the US. Currently, the role of Chairman and Chief Executive Officer Jamie Dimon is being put into question. Furthermore, the company's financial performance during these difficult conditions, specifically in the European region, will serve as a source of evaluation for the organization's capacity to grow in the coming years.
The issue regarding the possible shuffle in the upper management of the business has struck the media and has therefore, become a strong part of analysts' considerations. I find that it will make a substantial contribution towards the short term volatility of the company but in the long run, the impact is likely to be miniscule of any at all. Therefore, in this analysis, I intend to focus on both, the short term and the long-term aspects of JPMorgan.
Impact of Economic Environment
The US economy is currently facing a low interest rate environment as the Federal Reserve pushes its monetary stimulus to improve the status of macroeconomic indicators. The central bank is highly invested in the idea of increasing inflation and decreasing the unemployment rates. This decline in interests has already affected the margins of banks adversely.
Source: JPMorgan First Quarter FY13 Presentation
The above chart illustrates the trends witnessed in the net interest margins of the company in the past three years. The decline in margins due to the low interest rate economic environment is visible in this chart. I expect the margins to start recovering by the end of the second half of this year producing a positive outlook for FY14.
Indicators of Recovery and Financial Performance
The bank has shown substantial improvement in its performance over the years. A number of indicators support the notion of recovery in the coming years which are not only associated with the improvement of margins but also make a strong reference to asset quality.
Source: JPMorgan First Quarter FY13 Presentation
The chart above illustrates the performance of loans and loan reserves of JPMorgan since the beginning of FY11. We see that the asset quality of the company has shown a substantial improvement over the years as the non-performing loans have reduced and the company is confident about the quality of its assets as the loan loss reserves relative to total loans have reduced as well. JPMorgan is expected to witness similar marked improvements over some other business segments, specifically the mortgage segment, as housing prices start to rise and the housing industry begins its recovery.
Valuation and Upper Management Issues
JPMorgan has made huge sums of money under the leadership of Dimon which is why the issue of the company's Chairmanship has spread outside the boardroom. Members of the board recognize his performance as a CEO but intend to remove his Chairmanship. Dimon, on the other hand, has stated that he might leave JPMorgan if he is stripped of his chairmanship. I think that the shareholders will restore their confidence in Dimon and he will keep both positions. This news on its own will have a positive impact on the stock price.
The cheap valuation of the company also provides a promising upside as the company maintains some of its key valuation metrics below that of industry averages despite its superior performance.
The above table shows key valuation metrics of the company as compared to the industry and S&P 500. The undervaluation of the company is evident in these stats. Also, according to Bloomberg, the estimated PEG ratio of the company is 0.82 which supports the notion of undervaluation with respect to the strong growth prospects of the company in the coming future.
The banking industry is about to undergo another change of strategy as the economic recovery starts to come into play. The expense cutting and reserve releasing strategies have performed in recent quarters but in the coming future, growth appears to be the way to go. In this situation, JPMorgan stands to win with its strong financial performance and cheap valuation. Therefore, a buy recommendation is proposed for investors as JPMorgan is expected to come out as the winner of the banking industry in the recovery phase of the economy.