How To Get Into JPMorgan Chase (NYSE:JPM)

Prepared by Stephanie, Analyst at BAD BEAT Investing

Those who follow the chat frequently know that we said financials stood to gain from the amount of action being taken by the Fed and the government to prop up markets. JPMorgan Chase (JPM) was specifically asked about, and we said it’s definitely “best-in-breed.” We believe the PPP loans from the government is strong, with another round of funding recently approved, which was further bullish. On the downside, we have very low rates. We also have strong risks from loan forbearance, mortgage deferrals, and straight up defaults weighing on the sector. But, we have felt the name was a good buy from $85, and although we missed the recent bottom, we think this market gives us a leg down, or even a retest or approach of March lows in coming months as the real economic data weighs. So with earnings knocking the stock back a bit, here is how we think you can play JPM here.

The play

Three entry levels.

Entry 1: $89-$92 (25% of position)

Entry 2: $83-$85 (30% of position)

Entry 3: $73-$76 (45% of position)

Given that we expect a leg down again that may take a few months, if you are compelled to play call option that go as far out as possible and look to buy $90 strikes, $85 strikes, and $75 strikes as the name pulls back. Same type of pyramid in approach. Push it to January 2022 to maximize time. It is conservative, but smart.

We remain bullish and think it is a solid stock to not only trade, but to invest in the long term, which is why we want to scale in. We want to really hammer home the point that any multiple expansion you see is predicated on the future of the banking sector that will stem from continued global economic activity. Before COVID-19 was really on all of our minds, we thought 2020 was going to be a volatile year especially as we progressed through the election cycle. Recessions will come and go, cycles come and go, and we think JPM will thrive in any environment. But this environment is the most trying of my investing career, and I would argue, even more difficult than the financial crisis because it is self imposed and has led to the consumer economy being destroyed. But we are here to make you money, so our advice is to take a little off the table. We continue to believe that the reasons for owning a core position in JPMorgan Chase’s stock are for the future, and the operations in the recent quarter show it was getting ready to play defense.

Headline numbers looked awful

JPMorgan had a terrible quarter when it came to the headlines, though analysts really didn’t go nuts on changing estimates. No one really knew where it would come in. Overall the headline numbers reflected the pain of the COVID-19 crisis which has led to reduced demand, and changing banking activity from the norm. Of course, after a near 50% drop from peak to trough in the stock, well, we can see the market priced in disaster. Q2 may be terrible, but Q1 showed the pain began to weigh through March. Managed revenue was $29.2 billion, down about 3% year-over-year. This was below our expectations for $29.5 billion by $300 million. This broke a pattern of strong growth in Q1 revenues over the last several years:

Source: SEC Filings, graphics by BAD BEAT Investing

It is a result that appears disappointing and weighed on every down line item. Sad to see the reversal but still unsurprising. JPMorgan has surpassed our projections for the top line more often than not, and in 2019 it was like over $4 billion versus consensus. We obviously are ratcheting down our expectations for the year. Revenues were hammered. Despite this, operational expenses were hiked, while credit losses were atrocious, losing $8.2 billion versus an average $1.45 billion in each of the last 3 quarters. The past growth in Q1 earnings per share was lost:

Source: SEC Filings, graphics by BAD BEAT Investing

In last year’s Q1, the company saw earnings per share of $2.65, or $9.1 billion total. Despite a reduced share count and favorable taxation rates, those expenses and credit losses combined to whack earnings, hard, down to $0.78 or 70% to $2.65. The result missed our expectations for $1.88 by $1.10, and that was with us expecting higher revenues, and not nearly as many credit losses. Let us delve a bit into the major income metrics.

Interest and non-interest income

So those who follow our work know that when looking at a bank we like to look at both of the major classifications of income. Often times, they are dichotomous, with growth in one area and contraction in others. Much of this is about timing, and of course interest rates. That said, overall income is derived from interest and non-interest sources. Some concerns arise on the interest income side of the equation with lower rates, so that is something to keep an eye on. That said, JPMorgan continues to demonstrate strength in both these metrics. Over the years, the trend is higher for both measures. In the present quarter, non-interest income fell 5% to $14.5 billion thanks to a loss in Credit adjustment. Net interest income had grown for years, but now we are seeing the impact from rates. This quarter, net interest income was flat versus last year. The pace of growth has slowed down due to rates. It came in at $14.6 billion. Thus, the impact of rate cuts did not weigh as much as we thought. We do have to point out that assets under management increased to $2.2 trillion from last year. As assets under management continue to grow, it is important to look at any movements in the company’s provision for credit losses.

Loan growth continues along with provisions for credit losses

We saw continued growth in the loan portfolio from last year, as total loans were up 6% from last year. With rising loans we need to be mindful of possible credit losses, and believe me, those losses were huge. Provisions for credit losses were up from last year drastically, but even before COVID-19, things had been volatile, and had risen over time. When these provisions expand, we are cautious because it may mean the company is making risky loans, or borrowers may not be able to pay. In this case, it is the latter, with all of the unemployment creeping up, with small businesses not having revenue, businesses closed. The results are bearish on the economy, but the bank will do well in the medium-term.

We watch this as a measure for loan safety. Please note that this does not mean there will be losses, we just like to note how much is being set aside. Much of the reserves are in the consumer portfolios where much of the new loan activity is ongoing. The company entered this crisis in a position of strength, and still remains well capitalized and highly liquid with total liquidity resources of over $1 trillion.

It may not seem it, but JPMorgan Chase performed well in what was a very tough and unique operating environment, it grew loans, and was also growing deposits. In fact it grew deposits in every line of business and provided loans for customers at a high rate. While it is tightening some lending criteria, in the first quarter, the underlying results of the company were extremely good, however given the likelihood of a fairly severe recession, it was necessary to build credit reserves of $6.8B, resulting in total credit costs of $8.3B for the quarter. The provision was intentional.

Once Again, Highly efficient

One metric that has not seen improvement over the last few years is the efficiency ratio, but again, it doesn’t really matter because the bank is highly efficient. This means the costs expended to generate a dollar of revenue are attractive. As a whole, JPMorgan Chase has seen its efficiency ratio remain solid, though ticked up to 60%. Lower is better of course. While we have generally stuck with a textbook target of about 50% for this critical indicator, JPMorgan’s 60% efficiency remains among the best of the large banks on this critical metric, despite worsening.

Final thoughts

There is little doubt that JPMorgan Chase produced strong results in all of 2019, and this was a stark reversal. However, it should not be surprising. The company spent the quarter positioning for a recession, playing defense. We like that as investors after the stock is still off 33% from highs. Besides the virus, there remain complex geopolitical issues, and global growth now is a major concern. However, this virus issue will not last. It will be a few quarters of pain, and the economic issues will largely last through the end of the year. But the market punished JPM. We think you will get a chance to play this name again. You do not have to chase and bet it all here. Scale in!!! There is no reason to invest it all at once. If it goes up from your first buy, so what? A little profit does not hurt. It also preserves capital to buy either this stock or another at a discount. If you learn nothing else about investing or trading in this service, please consider what we have said here in the last few sentences. It is a key difference between being a winner and a loser.

The company still has a fortress-like balance sheet and is positioned to defend itself in coming quarters. We always contend that in the long term the ups and downs of the stock don’t matter, you should look to buy a quality company at a fair price. We have a high quality company here that is at a discount, even with EPS taking it on the chin for a few quarters. It is a winner long term.

Take home

Traders and long-term investors should take advantage of this stock. Scale into the name, you will be rewarded.

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Disclosure: I am/we are long JPM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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