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Buy Big Bank Stocks and Give Regionals a 'Breather': Merrill Lynch (Update 2)

JPMorgan Chase

JPMorgan closed at $41.38 Tuesday, returning 28% year-to-date, following a 20% decline during 2011.

The shares trade for 1.2 times tangible book value, and for 7.9 times the consensus 2013 EPS estimate of $5.22. The consensus 2012 EPS estimate is $4.76.

Based on a quarterly payout of 30 cents, the shares have a dividend yield of 2.90%.

For the 12-month period ended June 30, JPMorgan's ROA was 0.79% and its ROE was 11.32%.

JPMorgan Chase will kick off earnings season for large banks on Friday, with a consensus EPS estimate of $1.21, matching the company's second-quarter results, and increasing from $1.02 during the third quarter of 2011.

Penala's price target for JPMorgan Chase is $48.

The shares have recovered most of the value they lost following CEO James Dimon's announcement in late May that the company was facing large second-quarter losses from trading activities within its Chief Investment Office. JPMorgan announced soon after that it was suspending its share buyback program, but after the company achieved a $5 billion second-quarter profit, despite $4.4 billion in hedge trading losses, Dimon said that the company might be able to resume buybacks in the fourth quarter, subject to Federal Reserve approval.

Penala said that "the resumption of share buybacks in 1Q13 and '13 stress test approval should re-establish JPM as a capital return story." The analyst added that "over the next 2 years, we estimate JPM will return 20% of market cap to investors."

Penala also sees JPMorgan Chase benefiting from market rotation, as portfolio managers "incrementally invest in money centers like JPM given full valuations at regionals."

KBW analyst Frederick Cannon on Wednesday followed a similar theme of a bottoming for capital markets revenue, estimating that JPMorgan Chase will report "fairly solid results out of the investment bank," with fixed income trading revenue increasing to $3.525 billion from $3.490 billion in the second quarter, although the analyst also expects "a modest decline in equity trading to $930 million from $1,043 million in 2Q12."

Cannon also expects "investment Banking fees to improve modestly linked quarter at $1,275 million (up 23% year over year) driven by strong debt underwriting of $700 million ($639 million last quarter)."

"For JPM, we are forecasting two non-operating items in the quarter, a $900 million swap termination gain and $450 million DVA charge, so we expect reported EPS ($1.33), to be above operating EPS ($1.25)," Cannon said. He rates JPMorgan "Outperform," with a $49 price target.

Stifel Nicolaus analyst Christopher Mutascio expressed concerns on Wednesday over JPMorgan's net interest margin, which is the difference between the average yield on loans and investments and the average cost for deposits and borrowings. Mutascio said that despite the focus on JPMorgan's unwinding of the hedge positions that lead to its second-quarter trading losses, we are more focused on the company's net interest margin as net interest income still makes up roughly 50% of the company's total revenue base (versus roughly 10% for trading)."

"During 2Q12 the company's net interest margin compressed 14 basis points to 2.47%, resulting in a 4.2% ($496 million) sequential quarter decrease in net interest income," Mutascio said, and while "management has indicated the 2Q12 margin compression was not driven by the de-risking of the balance sheet in the aftermath of the London trading issues, we would have greater confidence in our 2013 EPS estimate if we were to see the margin stabilize in 3Q12. Without stabilization, we believe the risk to the consensus earnings expectations would be to the downside."

Stifel Nicolaus rates JPMorgan Chase a "Hold."

JPM Chart JPM data by YCharts

Interested in more on JPMorgan Chase? See TheStreet Ratings' report card for this stock.
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