J.P. Morgan: Banking-Stock Maverick?


With inflation worries mounting and the Federal Reserve still signaling increases in short-term interest rates, buying a bank stock is practically heresy on Wall Street this earnings season. Professional investors equate higher rates with squeezed bank profits, falling loan demand, and a slumping financial sector.

Higher oil prices and a flood of personal bankruptcies ahead of a tougher new law aren't helping the case for mammoth diversified banks, either. Citigroup (C), the nations largest financial firm, surprised investors on Oct. 17, with a 35% jump in third-quarter profits driven by strong corporate- and investment-banking business. Still, its stock fell, closing at $44.81 on Oct. 17, down 23 cents from the day before.

"There seems to be a conviction on the part of investors that you can't make money in banks and banks are in trouble, even though every company that has reported to this point reported better earnings than expected," says Richard Bove, an analyst with Punk, Ziegel & Co.

WAITING MONEY. Still, investors who shun the sector may want to take a closer look at the long-term prospects of JP Morgan Chase (JPM), which reports earnings on Oct. 19. It's more weighted towards strong investment banking and trading business than Citigroup, and, in President and Chief Operating Officer Jamie Dimon, it has a star CEO-to-be waiting in the wings.

At $34 a share, many analysts think JP Morgan looks cheap. "I'm looking at it as a long-term value play," says Mark Morgan, an analyst with Rochdale Securities, who rates it a buy. "At this point, it's hard to see the catalyst that will make it higher, but with a 4% yield, you're getting paid to wait."

Consensus estimates are for JPM to report earnings of 72 cents for the third quarter, a 20% year-over-year jump from the same quarter in 2004, according to earnings tracker Thomson Financial. Revenues are expected at $13.8 billion, a 10% gain from a year ago.

VALUE PLAY? Some analysts think earnings could come in better than expected. "We saw with Citigroup that corporate and investment banking carried the day," says Craig Woker, an analyst at Morningstar. "With JPMorgan, the impact is going to be even greater."

Ryan Beck & Co.'s Joseph Battipaglia sees JPM as an attractive as a way to play an expanding global marketplace for banking and improvement in capital-market activity (see BW Online, 10/12/05, "A Bull Slows Down His Charge").

The price-earnings ratio of 11.6 compares favorably to 12.3 for the banking sector and is a sizable discount from a p-e of 15 for the S&P 500. Standard & Poor's equity analyst Mark Hebeka notes its valuation is also much lower than historical levels. And Morningstar's Woker says his analysis shows JPMorgan to be the cheapest of the big banks based on discounted cash flow.

LEADER OF MEN. But the best reason for long-term investors to take a risk on JPMorgan Chase may be Dimon, who is slated to take over the CEO job from William Harrison, Jr., in June, 2006. A wunderkind with a knack for numbers, Dimon sharpened his talents for merging companies and cutting costs as Citigroup, where he was former CEO Sandy Weill's right-hand man for many years.

But it's his skill as a manager that has gone overlooked, says Jeffrey Cohn, managing partner of succession planning firm Bench Strength Advisors in New York.

"This guy has inspired Pied-Piper-like loyalty among his management team," he says of Dimon. "He inspires people in a way that very few people can do." Cohn believes the skill and experience of the operating team Dimon is assembling will show up in the next few quarters, even before Dimon takes the helm.

Bove notes that Dimon has "demonstrated that he has detailed knowledge of the business and a passion for solving business problems," which makes him perfect for the task at hand at JPMorgan Chase.

CASH MACHINE? That task -- which investors had been hoping to see more concrete results from by now -- is integrating Bank One, which J. P. Morgan purchased for $58.5 billion in early 2004, acquiring Dimon in the deal. Investors have been frustrated that the combination of the two companies has yielded less of a profit boost than hoped (see BW Online, 3/28/05, "Dimon's Grand Design").

Rochdale's Morgan believes the profit gains will eventually show up. "The cost savings are on track, but you can either have them drop to the bottom line or reinvest them in other things," he says. "Assuming they're high-return investments, then shareholders should see them down the road."

In general , 2005 has been a tough year for bank profits (see BW, 6/20/05, "Bond Woes Add To Banks' Problems"). But the problems are well known, and the stocks have fallen as a result (JPM is down 13%, Citi shares are off around 7%).

In about two years, Woker thinks JPM, thanks to its mix of businesses, could be a more powerful earnings machine than Citigroup. With Dimon at the helm, that goal may be within reach. Investors willing to bet on the future of JPMorgan Chase at a time when worries about banks are mounting, might prove the beneficiaries.

Stone is a senior writer for BusinessWeek Online


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