JPMorgan's Valuation Still Makes Sense

TheStreet.com

NEW YORK (TheStreet) -- Apparently JPMorgan Chase has not won over the investors it lost from the embarrassing "London Whale" trade last year. Despite the great job the bank has done to mitigate the damage, investors remain hesitant to embrace its recovery.

However, JPMorgan is still a dominant power in the financial sector. Very few can match JPMorgan's performance in terms of profitability and credit quality. Although the bank is not out of the woods by any stretch, the current valuation looks good. But management has to show better growth to get investors to believe.

On balance, JPMorgan's first-quarter report was good, not great. As with rivals Bank of America and Citigroup , there were plenty of ups and downs this quarter.

For instance, although JPM posted strong revenue of $25.8 billion that represented a 6% sequential increase, reported revenue was down 3% year over year.

Management said the year-over-year decline was due to soft mortgage banking and the continuation of production margin compression. Surprisingly, JPMorgan was outperformed by Citigroup, which posted 2% year over year growth in core revenue. Along similar lines, JPMorgan's net interest income wasn't any better.

As management alluded to, there were increased signs of margin erosion by a 6% year-over-year decline, and 2% sequentially. Likewise, net interest margin (NIM) fell almost by one-quarter point year over year. Initially, I was concerned by this. But there were NIM struggles across the entire sector.


For instance, Wells Fargo , which has had past struggles with NIM, didn't fare any better, posting a NIM decline of 33 basis points, which was also down eight basis points sequentially. What's more, Wells Fargo's net interest income also suffered a 3% decline year over year. Even though Citi showed some outperformance in revenue, Citi still posted a NIM decline of four basis points year over year.

So investors of JPMorgan can take solace in the fact that JPM's margin struggles looks to be an industry trend. Nevertheless, management deserves credit here for navigating this period of weak margins, which still lead to record profits of $6.5 billion, or $1.59 per share. But this is certainly a situation that bears watching going forward, especially if the revenue trajectory does not reverse course.

It wasn't all bad news. On the positive side, JPMorgan's strong showing in trading, although not a surprise, was able to offset some of the operational deficits. Likewise, management showed excellent fiscal awareness during the quarter as expenses declined more than 4% year over year.

What's more, although JPMorgan fell short on estimates for its pre-provision net revenue (PPNR), I'm willing to give management more credit for the fact that PPNR came in at double-digits. By contrast, Wells Fargo's PPNR advanced just 1% year over year and actually dropped 7% sequentially due a 4% increase in expenses.


Aside from the strong showing in trading business, JPM still has some work to do to perk up the bank's other segments. With growth looking pretty lethargic across the board, I wonder if JPM will turn to the old, reliable merger and acquisition discussions. This is often the first idea to get growth going again.

However, management's comments didn't suggest any type of deal was on the table. That said, it was nonetheless encouraging management didn't seem too rattled nor concerned about the subpar first-quarter results. Given that the performance was on-par with the rest of the sector, this stance was understandable.

Here's Making Sense

The results of this quarter notwithstanding, JPMorgan still has a strong business in investment banking, mortgages and retail banking. If the bank can continue to produce solid return on equity in the low-to-mid single-digits coupled with a discount rate of 9.5%, fair value on the stock can reach $55.

Given the potential for share buybacks over the next several quarters, along with an improving balance sheet, investors can still get a 20% premium just by being patient.

At the time of publication, the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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