Earnings Preview: JPMorgan - Analyst Blog

By Zacks.com, October 11, 2012, 04:50:01 PM EDT

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JPMorgan Chase & Co. ( JPM ) is set to roll out its third quarter earnings tomorrow morning, Friday, October 12. So, what's in store for the banking giant?

While last quarter's solid earnings surprise -- despite its 'London Whale' trading fiasco -- was sufficient to win analysts' confidence, a marked improvement in capital market activity and healthy mortgage business during the third quarter drove the estimates upward. The Zacks Consensus Estimate for the quarter is $1.21 per share, representing year-over-year growth of about 19%.

We believe the company is well poised to meet this expectation as the impact of last quarter's trading debacle has almost faded by now. In fact, the chance of reporting better-than-expected earnings is very high. If JPMorgan beats the Zacks Consensus Estimate this quarter, it will mark the company's third consecutive earnings surprise.

As a caveat, the recovery of the bond and equity market notwithstanding, the revenue is not expected to rebound significantly with fundamental pressures like low interest rate and sluggish loan demand still very prevalent. However, the offsetting factors could be favorable loan loss reserve and lower loss related to accounting adjustments (primarily the debit valuation adjustment).

Moreover, improving macroeconomic elements - such as a recovering housing market, modest inflationary pressure and lower unemployment - are expected to bring revenue stability for JPMorgan and the other major U.S. banks. The Zacks Consensus Estimate for revenue is $24.6 billion, up 3% over the year-ago quarter.

On the fundamental side, JPMorgan is trying to dodge the pressure on net interest margin, low liquidity and a stringent regulatory environment, which might mar its results to some extent. However, gradually improving retail banking performance and steady credit trends in its credit card business are expected to provide some perks.

Previous Quarter Performance

JPMorgan's second quarter earnings per share of $1.21 surpassed the Zacks Consensus Estimate by 55%. However, earnings decreased 5% from $1.27 earned in the prior-year quarter.

Due to an impudent hedging strategy, the company incurred a derivative trading loss of $4.4 billion (before taxes) in its chief investment office (CIO) for the period. However, a marked recovery of the bond and equity markets, and the consequent strong performances by its business segments, helped JPMorgan overcome its difficulties to a large extent.

Apart from the CIO trading loss, which impacted the results by 69 cents per share (after tax), JPMorgan's earnings per share for the second quarter included certain significant nonrecurring items such as a benefit of 16 cents from gains in the CIO's investment securities portfolio, a benefit from reduced loan loss reserves of 33 cents, a gain of 12 cents from debit valuation adjustment (DVA) in the Investment Bank and a gain of 9 cents related to loss recovery at Bear Stearns. Excluding these items, JPMorgan's earnings came in at $1.20 per share.

Results for the reported quarter primarily benefited from lower non-interest expenses and a substantial slowdown in provision for credit losses, partially offset by lower revenue. Almost all the segments except Corporate/Private Equity performed well, leading to such impressive earnings during the controversial quarter.

Managed net revenue of $22.9 billion in the second quarter was down 16% from the year-ago quarter. The figure, however, compares favorably with the Zacks Consensus Estimate of $22.7 billion.

Earnings Estimate Revisions - Overview

Ahead of the earnings release, the Zacks Consensus Estimate for the third quarter has moved up. A significant upward trend in estimate revisions is also palpable, making the strength in the stock more obvious.

We will now discuss the details of earnings estimate revisions to substantiate why both short-term and long-term investors should add this stock to their portfolio.

Agreement of Estimate Revisions

The estimate revision trend confirms that the majority of analysts are in agreement about a strong third quarter earnings at JPMorgan. Of the total 24 estimates for the quarter, 11 have been revised upward, while only 2 moved in the opposite direction over the last 30 days.

Also, for full-year 2012, out of 26 estimates, there were 11 upward and 3 downward revisions over the same time frame.

Magnitude of Estimate Revisions

The Zacks Consensus Estimate for the third quarter headed north by 5 cents or 4% over the last 30 days. For full-year 2012, the estimate increased 7 cents or about 1% to $4.74 per share over the same time frame.

Earnings Surprise

JPMorgan's performance has been almost stable over the trailing four quarters with respect to earnings surprises. The company has delivered positive earnings surprises in three of the trailing four quarters and missed in one, producing an average earnings surprise of roughly 19%.

How Attractive is JPMorgan Now?

The estimate revision trend indicates that fresh short-term investment in this stock will be a good decision from a price appreciation perspective. However, it may not be a good pick for investors looking for steady income in the medium term as the company's first priority will be to address its trading loss and the impacts of various regulatory and legal investigations related to its business operations.

Thus, it may divert its attention from enhancing shareholder value at least in the near-to- mid term. For instance, it has temporarily suspended its share repurchase program following the 'London Whale' debacle.

However, an income-seeking investor with an appetite to absorb risks ensuing from market volatility should not be disappointed with an investment in JPMorgan over the long haul as it pays an impressive quarterly dividend of 30 cents that yields 2.87% annually.

Also, from a risk perspective, as JPMorgan cleared the most difficult stress test, it is for sure that the company will be able to withstand another financial crisis.

Despite the macro pressure on credit quality, JPMorgan's credit metrics have been steadily improving since the final quarter of 2009. Though the provision continued to reflect elevated losses in the mortgage and home equity portfolios, we are impressed to see a modest improvement in delinquency trends and net charge-offs. We expect credit quality to continue improving, providing more room for bottom-line improvement.

Though there are concerns related to the impact of legal issues and its exposure to the European economy, equity-centric activities in the U.S. are expected to support JPMorgan's results in the upcoming quarters with continued recovery in the capital markets.

Yet, net interest margin (NIM) continues to remain under pressure, affecting the traditional banking businesses. Also, with the thrust of new banking regulations, there will be pressure on fees, and loan growth could remain feeble.

Conclusion

Going by estimate revision trends and the magnitude of such revisions, there is admittedly an upward pressure on the shares over the near term.

JPMorgan shares currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the company's business model and fundamentals, we also have a long-term Neutral recommendation on the stock.

JPMorgan, with exposure in almost all banking businesses, is one of the first two important bankers to kick start the third quarter results. The release is going to be a significant indicator of performance in the key banking sector. Wells Fargo & Company ( WFC ) is the other bank scheduled to release its earnings on the same day with JPMorgan.

Close on the heels of JPMorgan and Wells Fargo, the other major banks gearing to release their earnings are Citigroup Inc. ( C ) on October 15, Goldman Sachs Group Inc. ( GS ) on October 16, Bank of America Corporation ( BAC ) on October 17 and Morgan Stanley ( MS ) on October 18.