- JPMorgan accelerated its share repurchase rate in 2016.
- This doesn’t have a significant impact on fundamentals, but it signals to investors high levels of conviction in the macro environment.
- I believe, JPMorgan stock is heavily undervalued, and strength in fundamentals will materialize in 2016.
JP Morgan Chase (NYSE:JPM) was able to exceed expectations on share repurchases, which is heavily dependent on the Federal Reserve’s assessment of liquidity ratios and risk-weighted asset measures as a percentage of common shareholder equity, which is basically the total equity after excluding intangible assets. The company has been able to sustain the highest organic EPS growth among its peer group due to growth in its total assets under management, and capital preservation for high-quality loans in the consumer banking segment. Deposit growth has varied over the past five-year period but generally stayed at 9% due to its expansive branch network. The expansion of the network following its Washington Mutual acquisition in 2008 played a key role.
Also read: Which Bank Stocks Should You Buy?
The bank has recently reduced the scope of its branch network to be more heavily concentrated in rapidly growing suburban markets or mid markets where urban areas are expanding. I believe this strategy has translated into healthy enough deposit growth for JPMorgan to sustain enough high-quality liquid assets on its balance sheet despite holding onto higher risk assets like derivative contracts, and various other risky assets pertaining to its trading book as opposed to assets held by its consumer banking subsidiary, i.e. Chase bank.
The bank announced an increase to its share buyback program on March 17th. The incremental improvement of $1.88 billion to its share authorization improves the total share buyback rate to $3.18 billion in 1H’16.
Credit Suisse assess the impact in a recent report:
Estimates fine-tuned upwards. Factoring in additional share repurchase in 1H16 but tempering capital markets expectations near term, our 2016 estimate is unchanged, for now, at $5.55 per share. With the benefit of additional repurchase in 2016 and an increased repurchase authorization through the 2016/2017/2018 CCAR cycles (our model now assumes a 70% net capital pay out in calendar 2016, 76% in 2017 and 80% in 2018), our 2017E increases to $6.47 per share (old: $6.45); 2018E increases to $7.30 per share (old $7.25). In all cases, estimates remain quite sensitive to the macro environment (interest rates, credit quality, and the capital markets).
Currently, CS has a pretty aggressive price target of $75. However, it seems justifiable assuming mean reversion and sustained EPS growth of 10% to 12%. Given the current environment of weak sentiment for financial names in general, it makes sense that CS didn’t move its price target even higher.
The fear looming over energy assets and heightened potential of a wave of defaults by upstream energy producers has weighed heavily on the minds of investors recently. However, I don’t anticipate a stressed scenario to materialize. Furthermore, I believe the asset management and investment banking segment will improve due to market dependency and rising equity prices. The net interest margin spread will improve more modestly as expectations for rate hikes have been lowered to 50 basis points from 100 basis points in CY’16. As such, the sentiment on both macro and financial sector stocks has improved in the past couple weeks. Add in the fact that JPMorgan increased its buyback authorization and segment P&L from the trading/investment banking/asset management group will likely improve. Therefore, you have enough near-term catalysts to get really aggressive in the name.
Investors should get really aggressive on JPMorgan Chase stock despite the move above $60 following the announcement of an accelerated buyback program. While the EPS impact isn’t very material over the near-term, I believe there’s continuation to this trend of accelerated buybacks. I believe JPMorgan will return more capital over the next three-years, as capital requirements for globally systematically important financial institutions commonly referred to as the G-SIFI surcharge could be reduced by 100 basis points, which points to less need of liquid assets on the balance sheet. This will then lead to higher net capital payouts in the immediate three-year timeframe.
Furthermore, the bank’s efficiency on expenses will likely improve in the near term, as headcount reductions and efficiencies in the underwriting of loans through technological implementation should lead to meaningful cost recapture over the foreseeable timeframe.
As you are all well aware, banks are heavily macro dependent. I don’t believe the economic cycle will turn in the foreseeable timeframe. I anticipate the cycle to turn upon heightened loan originations in the 2020 to 2025 timeframe. I believe there isn’t enough lending to support the notion of a bubble, and the level of housing stock hasn’t increased materially enough to indicate that the cycle has yet turned. I believe that bubbles require a sustained period of loan originations and housing stock increases, but with new home construction well below the 2007 peak, I believe we’re still in a safe territory to harvest returns on the basis of mean value reversion and continued growth in fee-related income from various investment bank, brokerage, asset management, commercial and consumer bank activities. A bubble in credit just isn’t a factor right now, and with the Federal Reserve’s data dependent approach I find it highly improbable that the Fed will prematurely end the current expansionary cycle through rate increases or miss signaling.
Therefore, I continue to maintain my high conviction buy recommendation on JPMorgan Chase stock. I don’t have a price target in mind, but I believe sentiment will carry the stock to $70 before 2H’16 comes to a close.
Investors still have time to capitalize, so buy JPMorgan Chase stock on the cheap while you still can.