Earnings Preview: JPMorgan

JPMorgan Chase & Co. (JPM) is scheduled to report its third quarter 2010 results before the market opens on Wednesday, October 13, 2010. The Zacks Consensus Estimate for the quarter is 89 cents per share, representing a growth of about 11% over the year-ago quarter.

Seasonal reduction in July and August activities are expected to result in lower trading revenues in the upcoming quarter. Though concerns relating to the near-term impact of the financial reform law and suspension of foreclosures due to paperwork flaws have overshadowed its share price in recent days, the company is expected to report in-line results based on its rapidly improving fundamentals.

Previous Quarter Performance

JPMorgan’s second quarter earnings came in at $1.09 per share, substantially ahead of the Zacks Consensus Estimate of 71 cents. The results also soared from the earnings of 28 cents in the prior-year quarter.

The stupendous results were primarily supported by a slowdown in loan loss reserves, which more than offset the pressure on trading and investment banking revenues and a $550 million charge related to the U.K. bonus tax.

Managed net revenues for the quarter came in at $25.6 billion, down 8% from $27.7 billion in the year-ago quarter.

Earnings Estimate Revisions: Overview

Ahead of the earnings release, estimates have slightly moved down. The estimate revision trends and the magnitude of such revisions justify the weakness in the stock. We will now go through the details of the earnings estimate revisions to substantiate investor fatigue toward this stock.

Agreement of Estimate Revisions

Looking at the estimates revision trends, it becomes clear that a majority of the analysts are in agreement with the lower third quarter outlook for JPMorgan earnings. The following table shows that 5 analysts have lowered estimates for the third quarter of 2010, while 4 upward revisions were witnessed over the last 30 days.

Though for FY2010 there were the same number of upward and downward estimate revisions, for FY2011, 6 analysts have lowered their estimates and only 1 moved in the opposite direction.

Magnitude of Estimate Revisions

Estimates for the third quarter of 2010 deteriorated from the operating earnings of 90 cents per share to 89 cents over the last 30 days. Also, estimates for FY2010 and FY2011 moved down from earnings per share of $3.67 and $4.66 to $3.66 and $4.62, respectively. The magnitude of the downward estimate revisions indicates why adding JPMorgan to an investor’s portfolio is best avoided at this point.

Earnings Surprise

However, the following table shows that JPMorgan’s performance has been stable over the trailing four quarters with respect to earnings surprises. The average earnings surprise was a positive 39%. This implies that the company has beaten the Zacks Consensus Estimate by the same magnitude over the last four quarters.

Our Take

In order to comply with the Volcker Rule related to banks’ restrictions, JPMorgan has decided to close all of its proprietary trading. This is expected to hurt the company’s profitability to some extent.

A provision in the Dodd-Frank financial overhaul legislation passed in July, the Volcker Rule curbs the ability of banks to involve in bets with their own money. According to the JPMorgan management, the company will lose about $1 billion in revenue as a result of the derivative regulation under the new legislation.

Though credit metrics showed a slight improvement in the last three quarters, the overall pressure on credit quality remains a significant threat to profitability in the upcoming quarters.

Early-stage delinquencies across almost all of consumer lending areas (home equity, mortgage and credit card) are showing signs of stabilization. However, it is a bit early for any sustainable trend indication.

Though the company has been witnessing an improvement with respect to provision for credit losses in the recent quarters, a continued weakness in the credit environment will largely mar the positive effects.

The sluggish market recovery could potentially lead to reduced levels of client activity, lower investment banking fees and lower trading revenues. Also, earnings in the Commercial Banking and Treasury & Securities Services segments could decline due to the impact of tighter spreads in a low interest rate environment or a decline in the level of liability balances. An expected high level of consumer credit portfolio losses will also be a headwind to the overall profitability.

However, JPMorgan is poised to benefit from its leading businesses and large scale acquisitions. Each of its businesses ranks among the top three in the respective industry. The company is also pursuing acquisitions to build scale and volumes.

While we anticipate continued synergies from the company’s diversification and strong capital position, a pressured credit quality and the impact of tighter regulations in the new financial reform law will drag down future earnings.

The estimate revision trends, magnitude of revising the estimates and higher number of downward estimate revisions clearly portray the potential for significant downward pressure on the stock over the near term.

However, JPMorgan shares are maintaining a Zacks #3 Rank, which translates into a short-term ‘Hold’ recommendation.

Considering the company’s business model and fundamentals, we have a long-term “Neutral” recommendation on the stock.

JPMORGAN CHASE (JPM): Free Stock Analysis Report

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