JPMorgan Chase: Q3 Results Provide Ample Room For Further Upside

| About: JPMorgan Chase (JPM)

Summary

JPMorgan Chase beat the earnings estimates in Q3 by a wide margin, and now the picture is clearer in our view.

Improving margins, market revenues and disciplined cost management build a supportive case.

High card originations will be an earnings growth driver in the long term.

Solid operational performance justified a price target increase, now we see 25% upside potential.

JPMorgan Chase (NYSE:JPM) reported $6.3 billion in net income (-7.6% y/y, +1.4% q/q) in Q3'16 (ROAE: 10%, ROATCE: 13%), or a quarterly EPF of $1.58 that was way above the consensus estimate of $1.39. The beat in the third quarter was mainly driven by stronger market revenues, fast core loan growth, and better than expected asset quality evolution. JPMorgan Chase's earnings in 9M16 reached $18 billion, corresponding to 5% y/y decline. Following its results, JPMorgan Chase continues to be our top pick among mega-cap banks.

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JPMorgan Chase did quite well at increasing its market revenues during Q3 (investment banking fees +13.5% q/q, +16.3% y/y and principal transactions +16.3% q/q, 45.8% y/y) as the bank continued to gain market share, specifically in European markets. While many of Europe-based global investment banks face operational issues due to their weak capital structures, JPMorgan Chase takes the advantage of having stronger balance sheets. Going forward, fees from investment banking services tend to be more volatile given market swings. Still, we believe that the bank is well-positioned to capture more market revenues in the near term.

On the quarterly earnings conference call, we expected to hear a more positive tone to NIM outlook, nevertheless, we stick to our view that further NIM expansion is very likely. JPMorgan Chase registered a NIM expansion of 15 bps y/y in 9M15 as its average yield on assets and rates paid on liabilities rose by 0.26% and 0.13%, respectively. While banks mostly rely on an increasing Libor rates for margin acceleration, IOER and prime rates are decisive indicators in JPMorgan's case. Thus, we are convinced that the bank is the best tactical play ahead of an imminent rate hike in December. JPMorgan's the average yield earned on deposits with other banks is extremely Fed action sensitive of which balance totaled $409 billion in Q3. Our humble predication is that another 25 bps increase in Fed Funds rate could translate into 20 bps increase for yield on deposits, in other words, $800 million accretive to revenues in 2017.

Loan growth has been sustained at double-digit pace YTD. While commercial has remained the primary driver of loan growth, consumer loan growth now appears to be on the verge of turning positive. This is in line with our thesis that the overriding theme will be the increasing volume in consumer-wise financial products. H8 data also suggests an uptick in consumer loans, and particularly in credit cards. So, in our view the jump in credit card registrations came as no surprise. Given the bank's market share around 20% in credit cards, one should admit that JPMorgan Chase is well-positioned in a market that is set to grow fast. We think this, however, would have a modest impact on asset quality as the bank will have to build more provisions for potential credit losses for its credit cards portfolio that is an asset class with higher delinquency ratios. That said, we believe the CRE loans presents more near-term risks, as loan loss rates has remained extremely low for a long time.

JPMorgan released some of the reserves it built earlier for its oil& gas portfolio during last quarter. This was a key driver to bottom-line quarter. In one of our previous articles about JPMorgan, we wrote:

The bank had an exposure of $43.1 billion to oil and gas at the end of last year, of which roughly $14 billion was non-investment grade. Note that only a small portion of the total portfolio was given to exploration businesses which have taken the real damage. Allowances built for wholesale banking portfolio are now four times bigger than retained nonaccrual loans, which means that the bank has enough resources to absorb the losses stemming from business lending in case of a further deterioration in oil prices.

With oil prices stabilizing around $50 per barrel, we are likely to continue to see the continuation of strong credit performance regarding the wholesale loans in quarters to come.

Solid cost control continued to drive profit margin improvement as the marketing and technology investments are the two lines of non-interest expenses statement that has seen a y/y increase on a YtD basis. With more expense reductions kicking in, particularly in corporate and investment banking unit, we believe expense trends will remain benign in the upcoming period.

Whilst the stock is trading at a modest discount to its peers, we believe Q3 results, coupled with future earnings outlook should support stock performance in the near term. We increase our 12-month horizon price target of $74 to $85 which is based on the Gordon growth model and incorporates a 3% long-term growth rate, 12.5% normalized ROATCE, 9% cost of equity, and 2017E TBVPS of $54. Ultimately, JPMorgan Chase remains our top pick with 25% upside.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.