In yesterday’s (Saturday, October 7, 2023) blog post, the names of companies that were reporting this coming week that might have some interesting commentary, were posted for readers.
Today, we’ll look at the bank / financial companies in which client’s have an interest or might have an interest, and look at valuation and expectations coming into the Q3 ’23 earnings releases. First, let’s have a look at the financial sector in general and historical revenue and EPS growth.
Financials represent 12.7% of the SP 500’s market cap as of October 6th, 2023, but likely represents a larger “earnings weight” within the SP 500, although the exact percentage is unknown.
Financial sector revenue and EPS growth:
- Q3 ’24: +9.9% EPS grow estimated (no sector rev gro estimate available)
- Q2 ’24: +6% EPS gro estimated, (no sector rev gro estimate available)
- Q1 ’24: +4.7% EPS gro estimated, (no sector rev gro estimate available)
- Q4 ’23: +5.6% rev gro, +10.8% EPS gro (estimated)
- Q3 ’23: +2.3% rev gro, +11.3% EPS gro (estimated)
- Q2 ’23: 11% rev gro, and 9% EPS gro (actual)
- Q1 ’23: 10.8%, +7.7% (actual)
- Q4 ’22: +6.6%, -8.9% (actual)
- Q3 ’22: +7.8%, -16.3% (actual)
- Q2 ’22: -1.6%, -19.3% (actual)
- Q1 ’22: -2.2, -17.1% (actual)
- Q4 ’21: -4.0%, +9.9% (actual)
- Q3 ’21: +4%, 35.9% (actual)
- Q2 ’21: +6%, +158% (actual)
- Q1 ’21: +33.2%, +138% (actual)
- Q4 20: +3.3%, +20.4% (actual)
- Q3 ’20: +3.9%, -2.8% (actual)
- Q2 ’20: +5.9%, -46.7% (actual)
- Q1 ’20: -19.8%, -37.8% (actual)
- Q4 ’19: +23.8%, +10.2% (actual)
- Q3 ’19: +2.6%, +2.6% (actual)
- Q2 ’19: +3.5%,+10% (actual)
- Q1 ’19: +10.1%, +8% (actual)
- Data Source: IBES data by Refinitiv
Because the loan-loss provision for banks and major financials (that extend mortgage or personal credit) expand and contract like an accordion, banks are typically valued on a “pre-tax, pre-provision” profit basis. However, because of the increase in interest rates since early 2022, the analytical game has changed in terms of assessing risk for banks and financials, since it’s now more than just credit risk, as was discovered with Silicon Valley Bank (SVB).
Looking at the above data, financials have generated decent revenue growth in the first two quarters of 2023, probably on net interest revenue increases for the first time in a decade, however, looking at the above history COVID and the pandemic just wreaked havoc on the sector with the loan-loss provisions, then the loan-loss recoveries, and then increased loan-loss reserves again in early 2022 on the recession that never happened from the Wall Street firms that got it all wrong.
Both corporate and consumer credit have held up quite well despite all the negative prognostications the last two years. It’s the interest rate risk and the inverted yield curve that’s now causing problems, but the big banks are still probably the safest best in a tough-performing sector.
Let’s get at it by bank / financial company:
JP Morgan (JPM): JP Morgan is scheduled to report Friday morning, October 13th, before the opening bell, and consensus expectations as of today (October 8, ’23) are looking for revenue of $39.54 billion and expected EPS of $3.89 for year-over-year (y.y) growth of 21% and 29% respectively. Full year, 2023 “expected” EPS and revenue growth for the banking giant – as it stands today pre Q3 ’23 earnings – is +23% and +34% respectively, up sharply from consensus estimates stood in early January ’23. Last year, in 2022, JPM grew revenue and EPS by 7% and -22% respectively, so readers can see the bank is looking at much stronger results in ’23, although the stock is still trading heavy given the market action around financials.
The three year “expected” average revenue and EPS growth for JPM today, is 7% and 11% respectively. With the stock trading at an average of 9x EPS today, it’s still too cheap in my opinion.
When you look at this blog previous financial sector and JPM earnings previews, the “delta” to JPM EPS is the “corporate and investment bank” or what’s really the capital market operations, and in Q2 ’23, the CIB (as it’s called) was roughly 30% of both JPM’s net revenue and net income and in Q2 ’23, and it grew revenue and profits y.y 5% and 10% respectively after 4 straight quarters of negative growth in calendar ’22.
With the return of the IPO market and if and when the 10-year Treasury might peak, resulting in a return of corporate bond underwriting, it could help JPM’s overall results.
Summary / conclusion: In “normal times” if there is any such a macro environment, particularly with what happened in Israel over the weekend, JP Morgan is worth $180 – $200, since I think it can earn $18 – $20 per share, even with no multiple expansion, but eventually the bond market has to normalize. It’s a guess on my part but the acquisition of First Republic after the Silicon Valley Bank collapse, which was heavily accretive to JPM, might still have additional “accretion” left as JPM integrates the bank into operations. In addition, JPM has not increased their dividend for 8 quarters (going on 9 quarters if the dividend isn’t boosted in October ’23), and repurchases have not been as robust as they have been historically.
Given current consensus forecasts, here’s the next 3 full-year expected EPS for JPM:
- 2025: $15.75 (est)
- 2024: $14.83 (est)
- 2023: $16.08 (est)
In December, 2022, the 2023 full-year consensus estimate was $12.93 versus today’s $16.08, so investors have seen substantial positive revisions to JPM EPS in 2023 already.
Both the EPS and revenue revisions for JPM over the last year, remain firmly positive.
Stay with JP Morgan, it’s the best of the best in terms of the big banks. (JPM has been a top 10 client position since post 2008.)
Citigroup: (C): Citigroup is also expected to report their Q3 ’23 quarterly results before the opening bell on Friday, October 13th, 2023. Analyst consensus is looking for $19.26 billion in revenue and $1.19 in EPS for expected y.y growth of 4% and -21% respectively.
If we look at expected 3-year EPS and revenue growth, the rate of growth for both is expected to average just 2% for each (revenue and EPS) through 2025. (That’s pretty poor relative to it’s peers.) The stock is trading at a 6x – 7x multiple at $40 per share.
Here’s the issue: all the smart value investors like Bill Nygren at Oakmark and Warren Buffet at Berkshire Hathaway point to Citi’s book value of $98 per share and tangible book value of $89 per share say, “well, the stock’s too cheap at 0.4x book and 0.47x tangible book value trading at $40 per share” and they are right.
The problem is (as i see it) is that Citi’s ROE is horrid, at 7% – 9% annually versus JP Morgan’s return-on-tangible common-equity (ROTCE) of 15% – 17% and Bank of America’s 12% – 13% ROTCE target.
It isn’t that Citi isn’t too cheap at 0.4x – 0.5x book value – it’s that the assets they do have are not generating a sufficient return on equity relative to it’s peers and really relative to anything financial.
Jane Fraser, Citigroup’s CEO, has been saying for 18 months that expense and cost reductions are coming, and this was reiterated again recently, but we’ll see if it’s enough to boost ROE and thus – hopefully – boost the stock price.
C Summary: Citigroup at $40 per share is at the low end of it’s 7-year trading range reaching back to 2016. The stock is probably a lower-risk purchase here – even in front of earnings with it’s current 5% dividend yield – but Jane Fraser has to make a forceful statement with whatever Citigroup is contemplating in terms of cost reduction, and hopefully it will translate into higher ROE. No question that – on a valuation basis – the stock is cheap. (Clients are long a small portfolio weight in Citi, and I’d like to add more.)
Charles Schwab (SCHW): “Chuck” isn’t supposed to report until early next week, but it’s client 2nd or 3rd largest financial holding, and with the stock down -37% as of Friday, October 6th, it’s one of 2023’s largest underperformers relative to the SP 500 YTD.
Simply, the yield curve is killing Chuck, with fed funds at 5.5% and their income-generating assets at a much lower rate. The big news from Q2 ’23 earnings was that Schwab saw cash-sorting slow, and Schwab’s reliance on short-term funding was diminished, and the stock rallied about 10% – 12% following the Q2 ’23 earnings report. That being said, a lower effective tax rate added to the EPS upside in Q2 ’23 and thus lowered the quality of the earnings beat.
Today, the multiple has contracted significantly on Schwab’s stock, down from 20x in the 2nd quarter to 16x today, as both EPS and revenue expectations for Schwab, continue to be revised lower for the asset-gathering giant.
It’s not a great environment for Chuck or shareholders, as contracting NIM (net interest margin) and weaker stock and much weaker bond markets is compressing Schwab’s operating margin. In Q2 ’23, Schwab’s NIM contracted to 1.87%, and faces tougher comp’s on NIM until Q2 ’24.
The offset to that is that Schwab has always been rigorous about expense control and as NIM compresses, Schwab management can help offset the pressure with operating expense discipline.
Schwab put in a series of trading lows near $47 – $48 in April – May ’23 around the Silicon Valley Bank collapse. Schwab continues to be a top 10 client position even with the drop this year, thus only small positions may be added (if any) in the low $50’s as the plan is to see what Q3 ’23 earnings look like. With the Fed likely being done as inflation abates, a calmer yield curve, even if a normal slope doesn’t return for a while, will help.
Still, Schwab’s model would operate best with a normally-sloped yield curve and a “normal” fed funds rate closer to 2% – 3%.
Consensus estimates for the next 3 years reflect expected growth for SCHW of 12% in EPS and 6% in revenue, so with a 16x multiple, the stock now incorporates the slowing growth, although the question remains what’s in store for the bond markets and yield curve in 2024.
Schwab has been a sporadic share repurchaser, but has boosted the dividend nicely the last few years, so SCHW in the low $50’s is yielding almost 2%, not bond-like, but much higher than the last 13 year average.
Be patient, this stock and bond market environment is challenging the low-cost (former) discount broker, even as new new asset growth continues in the mid-single-digit range.
Summary / conclusion: Financials are typically a value sector and even more so this year given the underperformance relative to the SP 500’s YTD return. However there is value in the big banks that are more insulated from the yield curve inversion, unlike the regional banks, which are more exposed to the strict “lend at 6%, borrow at 3%” spread capture.
Readers might favor the more market-sensitive names like the brokers and the bigger banks, particularly if a Q4 ’23 rally happens in the SP 500. Investors are approaching the best 3-month period of SP 500 returns with October, November, and December upon us. Until the yield curve changes, regional banks are still probably a tough long until something changes with the short end of the yield curve.
YTD trailing-returns for above names:
- JPM: +11.22%
- C: -6.88%
- SCHW: -37.22%
- SPY: +13.58%
None of this is advice. Past performance is no guarantee of future results.
Thanks for reading.