JPMorgan: New Reasons It Will Trade Higher In 2013

| About: JPMorgan Chase (JPM)
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By Susan Wright

JPMorgan Chase (NYSE:JPM) has received approval from the U.S. Federal Reserve to buy back $3 billion in stock in the first quarter of 2012. It has signaled to the market its plans to engage in more stock buybacks in 2013. By these moves, it is clear JPMorgan is going to prop up its stock in the coming year. The question is, do the fundamentals of America's largest bank also need propping up? The bank is turning a corner on strong fundamentals and a gradual shake off of debts from the financial crisis.

Following a year of robust lending to American businesses and consumers, strong fundamentals underpin record third quarter earnings. Net income increased 34 percent to $5.7 billion on revenue of $25.9 billion, up 6 percent from the year-earlier period. The boom in its mortgage banking business as the housing market makes a comeback is helping to offset trading losses, and debt and expenses from the global financial crisis, triggered by the 2008 subprime mortgage crisis.

Across all of its businesses, JPMorgan Chase is showing good performance as it benefits from a low interest rate environment. Net earnings growth was led by a 21 percent increase in the retail financial services business over the year-ago period. The U.S. bank sector has been benefiting from a boom in mortgage banking. JPM had record originations in the quarter, up 29 percent to $47 billion.

Commercial banking earnings grew 21 percent as JPMorgan Chase registered its ninth consecutive quarter of growth lending to businesses, loaning $124 billion, up 29 percent from a year ago. All tallied, the bank lent $380 billion to corporations, $200 billion to consumers, and $15 billion to small businesses. Credit card sales were up 11 percent. The bank raised another $670 billion for clients.

Across its seven lines of business, only investment banking fell short. JPMorgan Chase was ranked number one in global investment banking fees for the first nine months of 2012 but was caught up in the downturn in global investment banking, which led to a 4 percent decline in profits. The bank's investment banking pipeline looks healthy for 2013 and will benefit from increased activity in Asia. It includes acting as a co-sponsor on the $1 billion IPO of Chinese diary farm Liaoning Huishan Holdings in the latter half of the year.

Low interest rates are helping JP Morgan Chase move past the financial crisis. It helps to have a turnaround expert at the helm. Chairman and CEO Jamie Dimon is known for his expertise turning banks into shipshape operations. It was Dimon's turnaround at Bank One that led to its purchase by JPMorgan in 2004. JPMorgan Chase's soft spot is its high debt of $707 billion and liabilities from the mortgage crisis. In addition to direct mortgage losses, the bank acquired Bear Stearns at the government's bequest, a move CEO Dimon says has cost the bank up to $10 billion in losses. Adding to this is a recent judgment for JPMorgan to pay Bear Stearns' shareholders close to $300 million for losses incurred between 2006 and 2008.

Large write downs in the quarter are helping JP Morgan clean up from the financial crisis and more recent financial mishaps. It reduced its loan loss reserves related to the mortgage crisis by $900 million. The firm expects to continue to incur high mortgage default expenses. In relation to large trading losses in its London office in 2011, a credit derivatives debacle called the "London Whale," the bank incurred a $4.4 billion pretax loss this quarter. At .91, JPMorgan Chase's current ratio - the ability to pay short-term obligations - is below 1. Free cash flow is -66.7 billion.

The debt reduction efforts together with the bank's recovery on strong earnings points to future margin expansion. JPMorgan Chase has an operating margin of 34 percent versus 39.32 for Wells Fargo and 17.99 for Bank of America. Its net interest margin of 2.43 has been steadily declining since 2009 and is just under the industry average of 2.92 percent. Both of these metrics reflect heavy debt obligations from the mortgage crisis but are expected to widen as debt is paid down.

JPMorgan Chase's planned stock buybacks, meanwhile, are helping it recover from the London Whale trading losses, which led to a fall in its stock price. The bank did $11 billion in stock buybacks in 2011, suspended 2012 buybacks after the London Whale losses and is expected to do at least $12 billion in buybacks in 2013. The bank trades at a price-to-earnings (P/E) ratio of 8.62 while competitor Citigroup (NYSE:C) trades at 15.18, Wells Fargo (NYSE:WFC) 10.38, and Bank of America (NYSE:BAC) 25.38. A low PEG of 1.17 indicates JPM is undervalued relative to its peers. In comparison, Bank of America has a PEG of 2.85, Wells Fargo 1.30, and Citigroup .72.

Following its record earnings quarter, earnings per share is 4.71 while Wells Fargo has an EPS of 3.18, Citigroup 2.37, Bank of America .37. The EPS average among JPMorgan Chase's industry peers is 1.34.

Other signs the stock is undervalued is a book value per share of 50 times, above its stock price which is hovering in the low 40s; and a price-to-book ratio of .81, well below the industry average of 5.05.

JPMorgan enters 2013 in its strongest financial position since the financial crisis. If America falls off a fiscal cliff, a possibility Chairman and CEO Jamie Dimon has been warning of in the press, the bank is buttressing against the potential of a recession. It is generating cash flow from operations of $83.46 billion and has $886.73 billion in cash and cash equivalents. Dimon has joined other CEOs in encouraging Obama to pay down America's fiscal debt to avoid a contraction in the economy.

Disclosure: I 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.