Event: JPM reports its Q1 earnings before the open on Friday Apr 12th. The options are pricing in about a 2.5% move based on the weekly straddle, relative to 2.75% avg. move over the past 4 and 8 quarters.
Sentiment: Wall Street analysts are bullish on the stock with 33 Buys, 6 Holds and 3 Sells, and an average 12 month price target of around $55. Short interest is negligible, at only 1.1% of float. Option open interest is almost evenly split between calls and puts, while the 1 month average volume has favored calls to puts by a ratio of 1.5 to 1.
Fundamentals / Valuation: The bull case for JPM is based mostly on its cheap valuation and free cash flow. Here’s the summary from GS Research:
Despite recent underperformance in JPM shares post-CCAR (-4% vs. BKX -1%), we believe the long-term thesis remains intact. From a price/earnings perspective, JPM is one of the least expensive banks in our coverage universe despite strong earnings consistency, a high near-term return on equity (15%+ ROTCE), and leading shareholder capital return. While late-cycle banks like BAC that are starting at a more depressed earnings level will likely have stronger EPS growth over the next few years, JPM still trades at a discounted multiple on normalized earnings without the execution risk of achieving consensus EPS growth estimates of 15-25% annually. To that end, we believe investors have a better risk/reward skew paying 7.9x 2015E EPS for JPM which is contingent upon a 7% EPS CAGR vs. paying 8.3x 2015E EPS for BAC which is contingent upon a 25% EPS CAGR. More so, we believe “normalized” earnings growth will be better for JPM as significant investments in growth initiatives over the past few years start to pay dividends.
On the capital return side, despite (1) being asked to “address weakness in capital planning” on the recent CCAR exam, and (2) a buyback announcement that was lower than expectations ($6bn), we do not view either as a read-across for future capital return capacity. Once JPM reaches its fully-phased Basel III target of 9.5%-plus by the end of this year and continues to mitigate risk-weighted assets through 2014, we estimate excess capital generation will equate to 120bp every year. This translates into room for a 3.5% dividend yield on current share price (assuming a 30% payout ratio) and $13bn of buyback capacity every year (7% implied yield).
The bear case is focused on the risk to earnings going forward due to increased regulations (such as the Senate’s recent proposal to force the largest 6 banks, including JPM, to raise significantly more capital), reduced risk-taking (especially after last year’s Whale incident), and a less favorable mortgage banking environment due to already low rates having translated into prior refinancing activities that won’t be repeated.
In the meantime, weakness in European financials has weighed on the financials sector in the last month.
Price Action / Technicals: The stock has found resistance near 50 multiple times in the past 5 years. Here is the 5 year weekly chart:[caption id="attachment_24493" align="alignnone" width="632"] 5 year weekly chart of JPM, Courtesy of Bloomberg[/caption]
While 50 is obvious resistance, the high from 2012 around 46 is likely near-term support.
Volatility: The 30 day realized vol (in blue) is near 1 year lows, and the 30 day implied vol (in red) is close to where it has been in the past couple times just prior to earnings:[caption id="attachment_24494" align="alignnone" width="676"] 1 year chart of 30 day IV vs. 30 day RV, Courtesy of LiveVolPro[/caption]
All in all, pricing for volatility seems relatively fair.
My View: In the past 3 years, the banking sector and JPM have had a strong start to the year, and then struggled after the first quarter earnings season. The earnings reports for the first quarter have generally been positive, but the price action after earnings was generally a result of overly optimistic expectations by investors and traders who had exuberantly bid up the sector in the preceding weeks and months. This year’s setup feels similar, but the broader macro environment is more likely to be a catalyst than individual earnings.