Why JPMorgan’s Shares Look Undervalued Despite Lackluster Q4 Performance

by Trefis Team
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JPMorgan Chase (NYSE:JPM) posted a weaker-than-expected performance for the last quarter of 2018 last week, as the sharp decline in equity and debt market valuations – coupled with seasonally low securities trading activity levels – weighed on revenues and earnings for the largest U.S. bank. However, the impact of weak trading revenues on the top line was mitigated to a good extent by continued improvement in the interest rate environment, which helped the bank’s net interest income figure, while upbeat card purchase volumes boosted card fees.

As has been evident from the earnings reports of the largest banks published over the last week, JPMorgan’s poor securities trading performance was due to industry headwinds. Although U.S. investors have expressed concerns over recent months about a slowdown in the near future, key economic indicators like GDP growth and employment rate remain strong. Additionally, JPMorgan’s dominant position across financial services including retail banking, investment banking, commercial banking as well as custody banking should allow it to benefit from positive economic trends, while also limiting the impact of negative economic conditions on its results (when compared to its less diversified peers). Taking this into account, we maintain our $120 price estimate for JPMorgan’s stock, as detailed in our interactive valuation model for the banking giant.

See our full analysis of JPMorgan

JPMorgan Will Continue To Reap The Benefits Of The Improving Interest Rate Environment

The rate hikes implemented by the Fed have helped the interest rate environment in the country recover steadily from the record low levels seen over 2014-2015. The ongoing rate hike process has resulted in JPMorgan’s NIM figure climbing from 2.22% in Q4 2016 to 2.54% in Q4 2018. The fact that the Fed went ahead with a rate hike in December highlights the regulator’s optimistic outlook for the country’s economy, despite the ongoing trade war with China. This makes it very likely that the Fed will raise interest rates at least a couple of times in 2019 – boosting JPMorgan’s NIM figure further this year. Taken together with steady expected growth in the banking giant’s loan base, this should translate into a record high net interest income figure of over $58 billion for full-year 2019, as detailed below.

Securities Trading Activity Has Already Recovered From Q4 Slump

The fourth quarter of the year is seasonally the slowest period for investment banking activities. Further, the situation in Q4 2018 was exaggerated by the sell-off in December that hurt securities trading revenues for all investment banks. But the equity market has reversed most of the losses seen towards the end of 2018 and is poised to continue its growth trajectory over coming months. At the same time, seasonally elevated debt trading activity should also boost JPMorgan’s FICC trading revenues, while improved market conditions should coax more companies to raise fresh capital – helping underwriting and origination fees.

Taking all this into account, we expect JPMorgan’s securities trading revenues and investment banking fees for 2019 to be comfortably higher than the figures for 2018. It should be noted that the securities trading revenues shown below only include trading commissions and mark-to-market gains, as interest income from trading securities are a part of the net interest income figure detailed above.

JPMorgan’s Focus On Asset Management Should Unlock More Value

JPMorgan has made considerable efforts over recent years to grow its asset management business – a decision that has helped its assets under supervision swell from less than $2.4 trillion at the end of 2016 to a record high of almost $2.9 trillion in Q3 2018 before it fell to $2.7 trillion following the equity market slump in December. More importantly, these efforts helped the bank’s asset management fees jump from $15.4 billion in 2016 to more than $17 billion in 2018. While JPMorgan has had some success with its line of exchange-traded funds (ETFs), we believe that the banking giant is poised to grow its presence in the rapidly growing industry through a sizable acquisition in the near future. This should have a significant impact on the asset management fee figure, as we forecast below.

Based on the key trends detailed above, we expect JPMorgan to report EPS of $10 for full-year 2019. Taken together with our forward P/E ratio estimate of 12x, this works out to a price estimate of $120 for JPMorgan’s shares, which is roughly 20% ahead of the current market price.

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