JPMorgan Is an 'Absolute Buy': Citigroup (Update 2)

Updated with market close information, JPMorgan CEO James Dimon's announcement of a suspension of common share repurchases, and reaction by Wells Fargo analyst Matthew Burnell.

NEW YORK ( TheStreet) -- Citigroup Analyst Keith Horowitz early on Monday made an "Absolute Buy Call" on JPMorgan Chase ( JPM), following an 18% decline for the shares, after JPMorgan disclosed its second-quarter hedge trading loss on May 10.

Horowitz's 12-month price target for JPMorgan Chase is $45, and the analyst expects the company to achieve a 14% return on tangible equity (ROTE) "in the near term with longer-term 16% ROTE potential."

JPMorgan Chase's shares closed at $33.49 Friday, returning 2% year-to-date, following a 20% decline in 2011. The shares were trading "at a 4% discount to tangible book" value, according to Horowitz, and for six times the analyst's 2013 earnings estimate of $5.20 a share. Horowitz estimates JPMorgan will earn $4.35 a share for 2012.

The analyst said that JPMorgan CEO James Dimon could "compensate for a lack of transparency" when he speaks at the Deutsche Bank Global Financial Services Investor Conference on Monday, and that "while he will not provide specifics on the hedge trading activity, we do believe there is a good opportunity to give investors a better explanation of how this happened, why they believe this is an isolated risk management incident," along with a report on "how much progress has been made in closing the open trading positions."

Horowitz added that "we would hope for a very clear statement that the dividend is not at risk and that buybacks are still expected in 2012."

Later on Monday morning, Dimon announced that JPMorgan Chase was suspending its share repurchase program, and that he the company planned to maintain its quarterly dividend of 30 cents a share.

The shares declined 3% on Monday, to close at $32.51.

Following the completion of the Federal Reserve's annual bank holding company stress tests in March, JPMorgan's board of directors had authorized $12 billion in common share buybacks for 2012, followed by another $3 billion for the first quarter of 2013. Guggenheim analyst Marty Mosby said last week that buybacks at lower-than-expected prices could help JPMorgan mitigate the effect of its trading losses on shareholders.

Based on "conversations with industry professionals and reports in the press," Horowitz said that his firm believes that "one element" of the trading activity that lead to JPM's announced $2 billion second-quarter trading loss was that the company "had bought near-term credit protection and then, in order to offset the costs, it sold longer-term protection in size," which would benefit JPMorgan "if there was a one-time event shock as near-term credit spreads would move higher than longer-term spreads."

"The issue," according to Citigroup, "is that after the trade was put on, the trade morphed into something else when JPM decided to take off that trade...and rather than reduce its original positions, we believe it layered on another trade that was intended to reduce its risk, but turned out to be ineffective."

Horowitz said that the size of JPMorgan's trading loss "relative to the earnings power is manageable, which is why we would not expect the dividend to be cut and why we still see buybacks in 2012."

With his announcement of the suspension of buybacks on Monday morning, Dimon seems to have settled the "bigger question is how aggressive they will be in their buybacks," which Horowitz had estimated would total $4 billion during 2012.

Horowitz estimates "roughly a $0.20 reduction in long-term earnings power" per share, from JPMorgan's trading losses.

In conclusion, Horowitz said that "as one of the highest quality stocks in our coverage, we feel very comfortable with the risk reward in JPM shares trading at 6.1x 2013E earnings (vs 8.9x for large cap peers)."

As JPMorgan continues working to unwind the hedge positions that led to the second-quarter trading loss, it's possible that Horowitz's buyback 2012 estimate may still hold.

Wells Fargo analyst Matthew Burnell said later on Monday following Dimon's presentation that the "suspension of the buyback offers support for JPM's core capital and common dividend," and that his firm believed "JPM could resume share repurchases by Q4 2012, assuming it can largely control the Chief Investment Office's hedging losses by that time."

Burnell rates JPMorgan Chase "Outperform," with a valuation range of $45 to $47.00.

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

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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