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We first created JPMorgan Chase & Co. (NYSE:JPM) to Long Idea in May 2020 as part of our thesis “See Through the Dip”. Since then, the stock has risen 37%, compared to a 42% gain for the S&P 500. Despite Slightly underperforming the market, we believe the stock is now worth $164+/share and is up 33%+.

JPMorgan’s stock shows strong rise based on:

  • net interest income growth forecasts in 2022;
  • diversified and global activities reduce risk;
  • strong generation of free cash flow (FCF);
  • the current price has a 33% upside if earnings return to 2020 levels.

Figure 1: Performance of long ideas: from publication date to 5/2/2022

JPM vs S&P 500 since May 2020

JPM vs S&P 500 since May 2020 (New Constructions, LLC)

What works

Steady growth: JPMorgan’s total assets grew 7% year-over-year in 1Q22 to $4 trillion, and average deposits rose from $2.2 trillion to $2.5 trillion in the same period. Average loans increased by 5% year-on-year (YoY) in 1Q22.

Rising interest rates: Economic growth and improving credit conditions in 4Q21 led to higher net interest income in the banking sector. This trend continued on JPMorgan’s earnings in 1Q22, when the company reported net interest income[1] grew 9% year over year (YoY). According to Figure 2, JPMorgan expects its net interest income to grow 19% year-over-year (YoY), from $44.5 billion in 2021 to $53.0 billion in 2022. These forecasts imply that net interest income will reach the bank’s second highest level in eight years. See Figure 2.

Figure 2: JPMorgan Net Interest Income: 2015 – 2022*

JPM net interest income since 2015

JPM net interest income since 2015 (New Constructions, LLC)

Focus on Free Cash Flow: As headlines cast doubt on the global economic outlook over the next twelve months, JPMorgan’s cash-generating business equips it to meet the challenges ahead. According to Figure 3, JPMorgan has generated $132 billion (37% of market capitalization) in cumulative FCF over the past five years.

For several years leading up to 2022, the market focused almost exclusively on revenue growth. Today, with the days of easy money in the past, the market is punishing cash-intensive companies harshly and will continue to do so until interest rates fall further. JPMorgan’s steady cash-generating activity provides stability and security in a market rationalizing value pricing.

Figure 3: Cumulative free cash flow: 2017 – 2021

JPM FCF cumulated since 2017

JPM FCF cumulated since 2017 (New Constructions, LLC)

Othe hat does not work

Investment banking woes: After posting strong gains in 2021, JPMorgan’s investment banking segment revenue fell 28% year-over-year in 1Q22 and sent non-interest revenue 12% below 1Q21 levels. However, JPMorgan’s well-diversified businesses reduce risk across the bank. Although investment banking fees declined in 1Q22, average loans, average deposits and net interest income increased over the same period.

Short-term risks are keeping equities down: In the near term, JPMorgan’s business carries downside risk if the yield curve continues to flatten or the economy slows further. In addition, rising interest rates could reduce demand for loans, even though corporate and consumer balance sheets are in excellent shape.

However, over the long term, JPMorgan’s market-leading position, strong balance sheet and critical role in the economy mean the bank will thrive in the long run. While we recognize that the uncertainty surrounding the current economy adds short-term downside risk to holding JPM, we believe investors should focus on the bank’s long-term position and track record of cash flow generation. We view any further downward movement in the stock price as an opportunity for investors to accumulate more stock given JPMorgan’s long-term competitive strengths.

Stock price set to only return earnings to 2020 levels

Economic uncertainty has pushed JPMorgan’s share price too low. Despite being the largest bank in the United States and growing earnings for decades, JPMorgan’s price-to-economic book value (EPBV) ratio is just 0.7, meaning the market is s expects earnings to fall permanently 30% from 2021 levels. Below, we use our inverse discounted cash flow (DCF) model to analyze expectations for future growth of embedded cash flows in a few stock price scenarios for JPMorgan.

In the first scenario, we quantify the expectations embedded in the current price.

  • The NOPAT margin falls to 24% (10-year average from 29% in 2021) from 2022 to 2031, and
  • revenues fall by 2% per year from 2022 to 2031.

In this scenario, JPMorgan’s NOPAT drops 4% compounded annually to $25.8 billion in 2031, and the stock is worth $123/share today, which is the current price. At $25.8 billion, JPMorgan’s 2031 NOPAT in this scenario is 1% below 2016 levels and 9% below its average NOPAT over the past decade.

Shares could hit $164+

If we assume that JPMorgan:

  • NOPAT margin falls to pre-pandemic 2019 levels of 25% from 2022 to 2031;
  • revenue grows at a CAGR of 4% from 2022 to 2024; and
  • revenues increase by only 1% compounded annually from 2025 to 2031; so

the stock is worth $164/share today, or 33% more than the current price. In this scenario, JPMorgan’s NOPAT increases by only 1% compounded annually and NOPAT in 2031 is equal to 2020 levels. For reference, JPMorgan has increased NOPAT by 8% compounded annually over the past decade and 10% compounded annually since 1998 (first data available). If JPMorgan grows NOPAT more in line with historical levels, the stock has even more potential.

Figure 4: JPMorgan Historical and Implicit NOPAT: DCF Valuation Scenarios

JPM DCF implicit NOPAT

JPM DCF implicit NOPAT (New Constructions, LLC)

This article was originally published on May 4, 2022.

Disclosure: David Trainer is the owner of JPM. David Trainer, Kyle Guske II, and Matt Shuler receive no compensation for writing about a specific stock, industry, style, or topic.

[1] This analysis uses JPMorgan’s management-derived net interest income measure which excludes CIB Markets, which includes fixed income and equity markets.

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