American megabank JPMorgan Chase (NYSE:JPM) has spent a great deal of time and money trying to patch up credit, legal, and business problems -- many of which were self-inflicted.
While JPMorgan emerged from the banking crisis with better capital and a stronger business than Citigroup (NYSE:C) or Bank of America (NYSE:BAC), the shares have actually underperformed those peers over the last two years as investors have been more intrigued by the self-improvement potential of Citigroup and Bank of America than the stronger underlying operating performance of JPMorgan.
Looking out, though, JPMorgan may be the better investment. Not only is the company a very strong player in trading and investment banking, it's near the top of the charts in mortgage lending, card lending, and retail lending, as well as sporting a large branch footprint.
With the possibility of double-digit cash earnings and ongoing dividends hikes (and/or buybacks), JPMorgan looks more than 10% undervalued today.
Another messy quarter
Earnings reports from large banks like JPMorgan are a mess, and will likely be so given all of the moving parts, charges, reserves, and revaluations. To that end, while the company's reported EPS appeared to miss the average Wall Street estimate, the underlying operating earnings performance was not bad.
Revenue was down 1% from last year on a managed basis (and up 1% sequentially), and this is likely going to be pretty typical for the cycle given low interest rates and very mediocre lending demand. Net interest income fell 2% as net interest margin declined 20bp, while income also declined on lower mortgage banking business.
Non-interest expenses would have been up about 3% excluding legal adjustments, and controlling/containing expenses remains a high priority for 2014. Credit quality is continuing its improving trend.
Sluggish lending still a headwind to growth
It's hard to make money when your business revolves around lending money and loan growth remains weak. Loans were up just 1% this quarter, with consumer loans down slightly and card loans flat.
The mortgage loan business continues to be a mixed situation for JPMorgan. Originations and application volumes were both quite weak, which makes JPMorgan's No. 2 spot in mortgages (well behind Wells Fargo (NYSE:WFC), who has more than a quarter of the market, but well ahead of U.S. Bancorp (NYSE:USB) at No. 3 in the mid single digits) not as impressive as it may sound.
Cards also continue to be a work in progress for JPMorgan. This bank relies on cards to a significant degree, as this business has historically contributed more than 20% of the bank's earnings.
JPMorgan has a huge portfolio (considerably larger than Bank of America or Citi) and management is trying to shift its focus from encouraging balance transfers to encouraging cardholders to use their Chase cards more often. That seems to be leading to better-than-industry transaction growth, but given JPMorgan's historically high charge-offs relative to its large bank peers, that merits watching.
Ready for the long run
There's no question that JPMorgan has given itself multiple black eyes recently. However, with good reason, JPMorgan is still standing, and still likely to generate double-digit EPS growth over the next five years.
First, only Bank of America and Wells Fargo have larger national deposit market shares -- giving the company a strong source of low-cost funds. Second, JPMorgan consistently scores well in consumer satisfaction surveys in consumer lending. Last and by no means least, the bank is a good identifier and keeper of talent, as seen in the company's consistently strong performance in trading, investment banking, and Institutional Investor sell-side research rankings.
The major legal issues are mostly behind the company, and its existing legal reserves should be sufficient to handle what remains. With that, JPMorgan looks poised to generate a five-year return on equity of 11.5%. That suggests low-teens EPS growth (even after including share buybacks) and an excess returns-based fair value of almost $65.
While banks like Wells Fargo and U.S. Bancorp are often touted as the best in class, JPMorgan's valuation and performance make it attractive. JPMorgan has the capital and the management ability to be a leader as major banks shift from fixing past mistakes to sustainable growth.