JPMorgan: Well Positioned To Steer Through Another Storm

Jun.28.12 | About: JPMorgan Chase (JPM)

Investment Thesis

There is no doubt that JPMorgan Chase & Co. (NYSE:JPM) faces significant near term risks, owing to the outcome of trading loss investigations and its GIIPS exposure, however, these risks have already been priced in by the market. Its balance sheet strength, capital adequacy to survive another deep recession, and its ability to capitalize on the optimism in the Housing Market, make JPM's stock a compelling long-term investment. The stock also offers an added advantage of a 3.2% dividend yield.

 

JPM

MS

GS

Market Cap:

135.94B

26.72B

46.41B

Qtrly Rev Growth (yoy):

4.0%

-8.0%

-16.0%

Revenue (NYSE:TTM):

90.49B

31.63B

26.87B

Operating Margin :

0.36

0.17

0.21

Net Income :

17.45B

1.26B

3.64B

EPS :

4.5

0.68

6.76

P/E :

7.93

19.75

13.46

P/TBV

1.07

0.54

0.69

P/S :

1.5

0.84

1.73

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Company Description

JPM, with assets under supervision and assets under management of $2tr and $1.4tr respectively, as of March 31, 2012, stands to be one of the largest banks in the United States. It provides diverse financial services to millions of customers in the U.S. The bank is divided into three large segments; Wholesale, Consumer and Corporate/ Private Equity. For the purpose of reporting, the bank's Wholesale Business is organized into Investment Banking, Commercial Banking, Treasury and Securities Services, and asset management. The bank's consumer segment is composed of retail financial services, and card services and auto sub-segments. JPM's Retail Financial segment is recognized as America's second largest mortgage originator, holding 10.6% of the market share, originating annual mortgages of $150b.

Earnings Review

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JPM reported growth in 1Q2012 revenues YoY. Total revenues of $27.4b produced earnings of $5.4b or $1.31 per share. Also, revenues were up by 6% YoY. Despite this increase in revenues, the bank experienced a 3% decline in its earnings for the quarter.

Segment Wise Overview

Retail Financial Services (RFS) remained the top contributor in 1Q2012 revenues, beating 1Q2011 Investment Banking contributions. RFS had a 27% share in 1Q2012 revenues followed by 26% for Investment Banking. Commercial Banking contributed the least with 6%. RFS also contributed the most with a 32.5% share in total earnings for 1Q2012, followed by a 31% share for Investment Banking. Corporate/Private Equity was the only segment that posted a loss in 1Q2012. Revenues from RFS also witnessed the largest increase over 4Q2011.

Investment Banking

Investment Banking revenues decreased by 11% to $7.3b from $8.23b in 1Q2011, reflecting the effect of lower investment banking fees. The bank was unable to earn higher investment banking fees due to lower industry-wide volumes in debt, and equity underwriting. However, net income for the segment decreased by 29% YoY to reach $1.7b. The segment was considerably affected by adverse debt value adjustments (NYSE:DVA).

Retail Financial Services (RFS)

This segment remained the largest contributor in both revenues and earnings for the quarter ended March 31, 2012. Driven largely by higher mortgage fees and related income, revenues for the segment increased by 40% YoY. The increase was partially offset by a decrease in credit card income. Earnings from the segment decreased by 4% YoY, reflecting lower loan balances due to portfolio runoff.

Within the RFS segment, the Consumer & Business Banking sub-segment saw a decline in its revenues of 4% YoY. The Mortgage Production and Servicing sub-segment posted an income of $461m compared to a loss of $1.1b in the prior year. Revenues from mortgage production increased by 80%, largely due to wider margins, favorable market conditions and product mix, higher volumes and increased refinancing due to HARP. Expenses from the sub-segment also increased by 35%, reflecting the impact of increased volumes and a shift to high cost retail channel. Repurchased losses decreased by 28%.

Optimism in the Housing Sector as reflected by an increase in single family new home sales, supported by increased refinancing through HARP, is going to favor JPM in the coming quarters.

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Card Services & Auto

Driven largely by lower average loan balances and narrower loan spreads, revenues from Card Services & Auto saw a decline of 2% YoY, however, earnings from this segment saw a decline of 23%, reflecting higher provision for credit losses.

Commercial Banking Revenues

Commercial banking revenues increased by 9% YoY to reach $1.7b. Improvements in revenues translated into an 8% earnings increase.

Capital

As of March 31, 2012, JPM had a Basel I Tier 1 common ratio of 10.4% and Tier 1 common capital of $128b, safely above the regulatory requirements. JPM also passed the Fed's last stress test, confirming that the bank has sufficient capital to survive a deep recession. Outside the U.S., JP Morgan had historically been concentrated in Europe.

Valuations

The stock presents attractive valuations when compared to most of its peers in the industry. The bank offers a higher return on asset (ROA) and return on equity (ROE) of 0.83 and 9.84 respectively, as compared to 0.57 and 8.62 for the average industry peer. The stock is trading at significant discounts of 53%, 66% and 48% to the average industry peers with regards to its price-to-earnings (P/E), price-to-sales (P/S) and price-to-tangible book value (P/TBV). The stock offers a dividend yield of 3.2% and has a year to date (YTD) performance of 2.2%.

Recent Developments

JPM recently reported a trading loss of $2b. When JPM Chief Executive Jamie Dimon announced the loss, he indicated that the figure could double within the next few quarters. The FBI, SEC, DoJ and CFTC have opened investigations into the matter. The SEC is investigating JP Morgan's disclosures to shareholders about the trading loss, while the FBI has also launched a criminal inquiry into the matter. It is too early to comment on the outcome of these investigations, however, one should keep in mind that it is not the role of these regulators to approve individual transactions for each bank. The loss has also triggered a discussion as to whether banks are too large to be managed. This loss is certainly not going to bring the bank down on its knees, and the effects have already been priced in.

As of January 2012, JPM had $15.1b of net exposure to Greece, Italy, Ireland, Portugal and Spain (GIIPS), 85% of which was exposure to Italy and Spain. JPM's European exposure (11.8% of Tier 1 capital) is not a substantial risk because of its small size relative to its Tier 1 capital of $128b. However, a severe recession sprung from the European contagion is a significant risk. This is why JPM is reducing its exposure to GIIPS nations and by the end of March 2012, the exposure has effectively reduced to $12.5b.

Click here for our detailed analysis on Citigroup (NYSE:C) Goldman Sachs (NYSE:GS) and Bank of America (NYSE:BAC).

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