- JPMorgan beat both on sales and earnings, as analysts were too conservative on trading revenues.
- The management team revised its outlook, so I have modeled my FY’16 estimates around those assumptions.
- After modeling FY’16, I believe there’s >19% upside to the stock.
JP Morgan Chase (NYSE:JPM) performed above street expectations due to its strong consumer banking franchise, which was offset by weakness in trading and 16% increase in non-performing loans. Approximately 90% of non-performing loans were due to energy, minerals and transportation. The bank believes that it will continue to extend credit to some of its non-performing commercial clients, but efficiency gains in operations and sustained growth in consumer and community banking is offsetting the weakness in its fee-based business.
In-line with earlier report, JPMorgan executed on some mega deals, so investment banking did better than some of the direr predictions. However, momentum in JPMorgan earnings doesn’t reflect on all other bank franchises, so I’m skeptical of stock price momentum in other names with the exception of Bank of America (NYSE:BAC)).
Despite these considerations, expectations were fairly low going into earnings as analysts on the sell side were anticipating JPMorgan’s consumer banking business to struggle in an environment of narrowing net interest margins. However, the net interest margin expanded by 7 basis points. This was driven by a 12 basis point improvement in yields offset by a 2 basis point increase in borrowing cost.
JPM’s consumer banking franchise is the strongest out of the group as the credit quality of its client pool reduced the risk weighing of its assets thus driving the common tier 1 equity ratio higher. So, the balance sheet looks even healthier following the quarter.
The continuing losses on the energy front isn’t eating too significantly into loan loss reserves, which may indicate a surprise in net charge-offs a couple quarters down the road. This is commodity price dependent. With crude oil moving higher it’s creating room for some upstream operators to remain more financially solvent. There was some back and forth commentary between Jamie Dimon (CEO) and Marianne Lake (CFO), which made it difficult to determine the severity of losses, but basically, Jamie Dimon isn’t too concerned with the quality of their commercial and industrial portfolio.
The company’s EPS came in above expectations as revenue and EPS came in at $24.083 billion and $1.35 respectively, compared to the analyst consensus of $23.4 billion and $1.26 EPS. Earnings and sales surprises are fairly common on a quarter-by-quarter basis as modeling bank earnings is the most difficult out of all financial sectors (maybe biotech is harder). The swing in earnings results were yet again significant, as the bank reported a 7.41% earnings beat. Investors were anticipating a really bad quarter with weakness across all reporting segments, but instead, the bank was able to show pockets of strength in some of its reporting units (consumer and commercial lending).
The bank’s losses from trading were far better contained, the y/y decline in FICC (fixed income, currencies and commodities trading) was 13%, the company also reported a 5% decline in securities trading. The impact was above expectations, but then again JPMorgan is a top performer among the major banks in fixed income, so it’s not really surprising to see JPMorgan mitigate its losses on this front. JPM’s team of analyst can give Pimco a good run for their money.
In terms of outlook, the bank is signaling a pretty robust recovery on revenue and net income front. My revenue estimate for FY’16 doesn’t correspond to the headline non-GAAP figure, as I make my estimate using GAAP revenue. That being the case, I have modeled out the assumptions of the management and arrived at a GAAP Diluted EPS estimate for FY’16. My EPS estimate does compare to consensus estimates as I replicate the company’s accounting foot notes.
From my understanding, JPMorgan’s management is anticipating the fee based businesses, i.e. the investment bank, trading and asset management business to recover quite swiftly throughout the course of the year. Furthermore, the bank’s net interest income growth seems consistent with their ability to grow deposits and lower risk in consumer banking despite the widening of losses due to charge-offs in commercial banking. The consumer side significantly mitigates the downside from commercial/wholesale banking.
Of course, I’m working with roughly $4.75 billion in provisioned credit losses for my estimates in FY’16. Of course, they may provision for more losses down the road so there’s room for greater error. But, given the limited exposure to oil and industrial, and the on-going recovery in crude oil prices there’s ample room for speculation on narrowing loan losses.
Furthermore, litigation expenses are difficult to predict but is expected to drop off quite considerably following the recent settlement over the Lehman Brother lawsuit, which was paid out in Q1’16. The $1.42 billion impact was reflected in the current quarter, and JPMorgan may have a clean streak (hopefully) for the remaining duration of the year. It’s probably only a matter of time before JPMorgan pays out $2 billion worth in litigation related settlements though (believe me something always happens), so I’m not getting my hopes up.
As it currently stands, I’m anticipating Diluted EPS of $6.12. This figure is roughly 8.9% above the analyst consensus. However, I believe these figures are attainable (given average EPS beats for the prior four quarters was 10.55%). JPMorgan won’t sustain EPS growth of 12% for the current FY, but I anticipate a fairly robust recovery in FY’17 given mortgage interest rates bottoming and potentially trending higher.
That being the case, investors should anticipate the analyst consensus to raise estimates and price targets. While I did receive preliminary commentary, I haven’t received a whole lot of estimate changes (yet). The follow-up commentary will likely arrive tomorrow. I’m anticipating estimates to be revised higher on a lot of sell-side models, which will drive the consensus EPS estimate range higher. Of course, I have already taken the liberty of adjusting estimates to conform more to management’s revised outlook, so I feel pretty confident coming out of the quarter.
Of course, I have already taken the liberty of adjusting estimates to conform more to management’s revised outlook, so I feel pretty confident coming out of the quarter. Ironically, operating results will likely pick-up momentum (due to cost reductions), but taxes are going to normalize at approximately 27% in FY’16. Furthermore, I’m anticipating the share count to decline by 3.35% assuming total share repurchases of $8.28 billion at a $69.50 cost basis, which is $7.71 above Wednesday’s closing price.
I’m initiating a price target of $73.93 (12.08x EPS), which is 19.6% above the prior close. I believe upside will mostly be driven by recovering sentiment in financial sector stocks. The group has been a laggard, but of the laggards I continue to view JPM as the best house on a bad street. As such, I’m going to reiterate my high conviction buy recommendation following what has been a solid quarter.