JP Morgan (JPM) is one of the world’s banking giants that provides retail and commercial banking under the Chase brand and asset management under the J.P. Morgan brand. The company's lucrative hedge fund business, which manages wealth for private investors has assets under management (AUM) of $54 billion, making it the second largest hedge fund operation in the world.
Like most of the rest of the banks in the United States, JPM received government money from the bailout of the sector due to the financial crisis in 2008. It repaid the last of the $25 billion it received in late 2009 when the Treasury sold 88.4 million warrants with a conversion price of $42.42 per share. The key takeaway from this event is the green light the company has received to raise its dividend to historic levels. Without government ownership, JPM will have more control over what it does with its cash and cash flows. With each dividend increase, JPM shareholders will likely be rewarded with real price appreciation in the shares.
JPM shares are currently trading around $33, and the mean 12 month price target from analysts researching the stock is $46.97 (43% upside potential). This stock is trading below its 50-day exponential moving average of $33.8, and below its 200-day exponential moving average of $37.9. Technically, the share price has recently turned to the positive leg of a classic Elliot wave, and I would expect the stock to move higher in the medium term.
Earnings per share for the last 12 months are $4.69, and the EPS number is expected to rise to $4.93 in the next fiscal year (ending Dec 2012). These numbers place the shares on a trailing price to earnings ratio of 7, and a forward multiple of 6.65. This is around the level of competitors such as Bank of America’s (BAC) forward price to earnings ratio of 6.15, Citibank’s (C) at 6.58, but below Barclays PLC’s (BCS) at 14.08. While these comparisons are meaningful because investors are buying these earnings when they buy shares, JPM looks particularly cheap on a growth basis. The company's PEG ratio (using 5 years expected data) is a low 0.82. This compares to a negative -17 for BAC, meaning the company's earnings are expected to shrink over the next five years, and a PEG of .98 for BCS. Thus, BCS, arguably a weaker franchise with less connections that are important in commercial banking and wealth management, is for sale at a higher price than JPM on a growth basis.
For investors looking at dividend paying stocks, JPM’s payment of a quarterly dividend totalling $1.00 last year gives the stock a yield of 2.90%. This is covered 4.7 times by its earnings, which is ample coverage, and more importantly, already offers room for growth. This yield is more attractive than Citigroup’s (C) yield of 0.10%, BAC’s yield of 0.60%, and BCS’ yield of 2.20%. Institutional dividend funds will be comparing this metric in their evaluation of what to buy. As a significant part of the market, this is a meaningful comparison.
Current operating margin at JPM is 39.92%, with a return on assets of 0.91% and a return on equity of 11.28%. BCS’ operating margin is 26.16%, and its return on equity is 5.87%. This comparison demonstrates the value of JPM's franchise relative to its peer. The PEG analysis above is validated by JPM's superior margins.
The current revenue from JPM’s income statement is $93.43 billion, though last quarter’s revenue showed only a modest year on year growth of 3.60%. JPM has cash of $895 billion, and debt of $737.8 billion. Its reported book value is $45.21 per share.
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Looking at the 12-month chart, shareholders in JPM have had a tough time over the last 12 months. Though the dividend softens the blow, shareholders are still over 10% down over the period. However, the shares have improved sharply since hitting their year low of $27.85, and could improve further from current levels, though this improvement is likely to be volatile.
With the global financial situation looking strained, it is worth noting the following negative items of news:
- The company’s third quarter results were tainted by charges connected to legal fees for connected to loans and securities.
- The company is subject to a $19 billion lawsuit bought by former customers of Bernard Madoff;
- As of September 30, the company’s net exposure to Italy was $5.5 billion. This includes collateral and hedging positions.
The big cloud on the horizon for JP Morgan is its exposure to Italy, which seems to be on the brink of a serious sovereign debt crisis as economist Monti has been nominated to replace Berlusconi. However, even a complete loss would shave 5% off of the company's $122 billion market cap. Using the Greece bailout process as a guide, a 50% haircut on JPM's Italian assets would mean a 2.5% hit to the market cap. JPM's other assets would more likely rise in paper value, rather than fall under a negative scenario because most of the European risk is "headline risk" to the company.
In other words, a fear premium (which can be seen in JPM's put option premium expansion over the last few months) due to European risks has increased. Added to this is the spectre of the Bernard Madoff lawsuit. Private plaintiffs are seeking $19 billion after the $6 billion suit by the trustee for the Madoff asset fund was thrown out due to lack of standing. The trustee lawsuit has serve as a guide-- the $19 billion figure is likely an inflated version of the trustee's claim, in order to anchor JPM at a higher figure. A settlement, if any, will take years to work out, and, in any event, would come in around the trustee figure of $6 billion. This represents 5% of JPM's market cap.
Taking the negatives in combination, the stock still trades at a PEG of approximately 0.9 which is still a considerable discount to its peers. In otherwords, JPM is oversold. On the positive side, shares are trading at an undemanding price to earnings ratio, and should be underpinned by both the well-covered dividend and the discount to current book value. The technical trading pattern has turned positive, if choppy, and I see room for improvement in the share price. The global macro economic difficulties, and the fear of contagion from Europe’s debt problems, will weigh on the share price in the short term, but overall I see the shares as a relative value with multiple catalyst ahead--from a rising dividend.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
