JPMorgan's Stock Is Cheap Even With Regulatory Pain in 2014: KBW

NEW YORK ( TheStreet) -- Shares of JPMorgan Chase ( JPM) trade at a relatively low premium to consensus earnings estimates, and the multiple remains cheap even when factoring significant hits to 2014 earnings from new capital requirements and the Volcker Rule, according to KBW analyst Christopher Mutascio.

JPMorgan's shares closed at $55.49 Tuesday and traded for 9.10 times the consensus 2014 earnings estimate of $6.10, among analysts polled by Thomson Reuters. In comparison, Bank of America ( BAC) traded for 10.7 times the consensus 2014 EPS estimate of $1.37, based on Tuesday's closing price of $14.64. Wells Fargo ( WFC) closed at $44.03 Tuesday, trading for 11 times the consensus 2014 EPS estimate of $4.02, while Citigroup ( C) closed at $51.48 and traded for 9.2 times the consensus 2014 EPS estimate of $5.57.

So among the "big four" U.S. banks, only Citi trades at a lower valuation than JPMorgan Chase. And Citigroup is a long way from achieving returns on equity as high as JPMorgan. Among the big four, only Wells Fargo has consistently outperformed JPMorgan Chase.

Taking consensus estimates out to 2015, JPMorgan is the second-cheapest among all U.S. bank stocks for which consensus estimates for that year are available.

So what are investors afraid of? After all, JPMorgan earned a record $21.3 billion in 2012, or $5.20 a share, despite booking at least $6.4 billion in losses from the "London Whale" hedge trading problems. The company reported second-quarter earnings of $6.5 billion, or $1.60 a share.

Investors are concerned with federal regulators' recent proposal for higher minimum supplementary Basel III Tier 1 leverage capital ratios for the nation's highest banks. Under Basel III, the largest banks need to calculate a "supplementary" Tier 1 leverage ratio, which incorporates off-balance-sheet items. Under the Basel agreement, the minimum supplementary Tier 1 leverage ratio is 3%, but for the largest U.S. banks the new proposal requires a minimum of 5%, with affected holding companies required to maintain supplementary Tier 1 leverage ratios of 6%, by January 2018.

In addition to JPMorgan's multiple regulatory investigations, investors are concerned that the Federal Reserve's pending finalization of the Volcker Rule's ban on proprietary trading could cause trading revenue to sink considerably during 2014.

One regulatory investigation was recently settled when the company agreed to pay $410 million to settle charges of energy market manipulation.

Before the settlement was announced, JPMorgan said it was considering " strategic alternatives" for its physical commodities business, including energy trading, which would also lower its trading revenue.

KBW's Mutascio in a report on Tuesday considered the effects of a possible preferred equity raise and trading revenue decline in 2014 on JPMorgan's earnings estimate and share-price multiple.

JPMorgan estimated its supplementary Basel III Tier 1 leverage ratio was 4.7% as of June 30.

"In our analysis, we assume the holding company will maintain a leverage ratio of 6% -- not the 5% proposed by the Fed. In doing so we are ensuring the company maintains an internal buffer over the 5% as well as some capital cushion to downstream to the bank subsidiary level, if needed," Mutascio wrote.

Factoring in JPMorgan's estimates of $3.5 trillion in leverage assets under the proposed leverage capital rules, Mutascio estimated the company would need $45.5 billion in additional capital to bring the supplementary Basel III Tier 1 leverage ratio to 6.0%.

Based on Mutascio's 2014 EPS estimate of $6.25, along with a similar dividend payout ratio and share buyback plan as JPM put in place for this year, the analyst estimated "the company can generate $21 billion in organic capital."

"We have assumed the remaining $24.5 billion shortfall is covered equally by the rationalization of risk weighted assets and the potential for the issuance of preferred stock," Mutascio wrote. If JPMorgan were to issue $12.25 billion in preferred stock, it would lower KBW's 2014 EPS estimate by 19 cents to $6.06.

Moving ahead to expected revenue declines from selling the physical commodities trading business and the Volcker Rule, Mutascio estimated that with a $4.0 billion or 32% decline in gross fee revenue, "assuming a 35% tax rate as well as a 35% comp ratio," JPMorgan's earnings would decline by a further 45 cents a share, for a 2014 EPS estimate of $5.61.

That would be a 10% earnings reduction for JPMorgan, and the shares would still be trading cheaply, at 9.9 times that hypothetical estimate.

Mutascio rates JPMorgan "outperform," with a price target of $63.

JPM Chart JPM data by YCharts

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


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

>Contact by Email.

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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