Last week was one of the worst weeks for equities in a long time. While everyone is panicking, it's time to start looking for opportunities. One of the companies I'm looking at is JPMorgan (JPM, Financial), of which I have written multiple articles the last few years.
The company has seen its shares fall along with the rest of U.S. equities. JPMorgan is one of the largest banks in the U.S. and highly profitable despite the zero-interest rate environment created by the Fed. However, the Fed raised rates by 0.25 basis points last month, which will be a positve for the U.S. banking sector as a whole.
The selloff last week has created an opportunity to load up on shares of JPMorgan at $58 per share.
Business overview
JPMorgan is one of the best-managed and profitable banks in the world. From consumer banking to investment banking, JPMorgan stands out in every aspect of its business compared to its competitors. JPMorgan is the largest bank in the world with $2.4 trillion in assets. The company operates in 60 countries and has been in business for more than 200 years. Even after paying out $24 billion in SEC fines for wrongdoing by Bear Stearns and Washington Mutual, which the company acquired in 2008, JPMorgan's underlying earnings haven't been affected.
JPMorgan provides its services through more than 5,000 branches and 18,000 ATMs throughout the U.S. The bank has more than 19 million active mobile users, who access numerous JPMorgan services through their phones.
The Consumer and Cummunity Banking (CCB) business unit is the largest segment of revenue for JPMorgan, making up 46% of the company's total revenues. This is followed by Corporate and Investment Banking (CIB), which makes up 34% of total revenues, while the remaining two units contribute 12% and 7%. JPMorgan has been growing its deposits at an annual compound rate of 8%.
The company is seeing headwinds from government ligation and higher Basel III capital requirements. JPMorgan is being forced to raise its equity capital by $15 billion by 2019. This will lead to compression in JPMorgan's return on capital for the next couple of years. The Fed won't raise rates in September, which will probably lead to a selloff in bank stocks. Banks like JPMorgan have been interest rate starved over the last seven years due to the zero-interest rate environment.
Normalization of interest rates
Over the last few years JPMorgan Chairman, President and CEO Jamie Dimon has given multiple presentations on how the normalization of interest rates would produce higher earnings for JPMorgan. Under the Fed's normalization of interest rates, JPMorgan could see $30 billion in earnings in 2017. When you subtract $1.1 billion in preferred shares dividends and other distributions to shareholders, it would result in $28 billion in earnings in 2017.
On a per-share basis, JPMorgan could produce $7.57 per share. Before the financial crisis JPMorgan traded at a P/E of 12x. If interest rates rise and JPMorgan trades for 12x its earnings, shares would sell for $91 apiece.
Valuation
Currently JPMorgan is selling at a 20%-plus discount to estimated intrinsic value. JPMorgan is projected to have earnings of $5.90 per share for 2015. Based on this projection the company is selling for less than 10x its earnings. The company has a forward P/E of 8.64 which is less than the industry average of 12x earnings. JPMorgan's earnings have been compressed by the zero-interest rate environment. Thanks to the global market selloff JPMorgan is selling for 7.3x its operating earnings.
Raising rates will lead to JPMorgan's earnings reflecting the underlying economics of the business. The $91 per share value depends on the Fed continuing to raise rates throughout 2016. However, with the global market currently melting down, the Fed may panic and not raise rates or go to negative rates. Even without the normalization of interest rates, JPMorgan is undervalued at its current price of $58 per share.
Due to what is happening globally, JPMorgan is selling for 7.0x its operating earnings of $7.8 per share and 7.3x its 10-year average operating earnings of $8.04 per share. At a reasonable multiple of 10x, JPMorgan's value is between $78.40 per share and $80.04 per share.
