Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 07 April 2017 at 11:45 GMT

Earnings Watch: US banks and the fading reflation trade — #SaxoStrats

Head of Equity Strategy / Saxo Bank
  • Luxury segment on the rebound as Chinese demand rises
  • Fed normalisation means tailwinds for US banking sector
  • Saxo quant model more positive on JPMorgan than on Citi

Thursday sees some of the US' largest banks releasing earnings 
prior to the New York bell. Photo: Shutterstock

By Peter Garnry

The Q1 earnings season (for those companies following the calendar year) begins next week with 22 of the 2,000 companies that we track during the earnings season reporting. In today's Earnings Watch, we will focus on LVMH, JPMorgan Chase, and Citigroup.

Luxury is on fire

LVMH reports Q1 earnings on Monday with consensus looking for earnings-per-share at €3.79, up 10% (year-over-year) and sales at €19.1 billion up 11% y/y on a strong rebound in luxury demand from China as the country's economic sentiment has improved dramatically over the past year. 

Investors have responded by lifting the share price by 43% since early 2016. In addition to rising demand from China and Hong Kong, luxury inventories across soft and hard goods have normalised so a new inventory cycle could lead to strong 2017 gains.

LVMH weekly share price
LVMH share price
Source: Saxo Bank

LVMH's CEO recently said that Chinese sales have been strong in Q1, so we would not be surprised to see the company positively surprise on EPS and sales against estimates. In terms of valuation, LVMH shares now trade at the highest one-year forward P/E ratio since 2004 at 22 compared to an average of 16.3.

Despite this elevated valuation, the stock is heavily recommended by sell-side analysts. Our quant model scores LVMH at around the average, so we are neither positive or negative.

Cyclical and secular tailwinds for US banks

While the reflation/Trump trade has faded in recent weeks, the Federal Reserve is still on track to deliver multiple rate hikes this year with the first already behind it. Higher rates short-term and a positive rate hike trajectory create both cyclical and secular tailwinds for US banks; JPMorgan Chase, Wells Fargo, and Citigroup are all reporting on Thursday before the market opens.

Analysts expect JPMorgan Chase to report Q1 EPS at $1.52m up 8% y/y, and net revenue at $25.3bn, up 5% y/y. 

Given the firm's single-digit growth rates, one might wonder why shares are up nearly 50% in only two quarters and trading at the highest forward multiples since the end of the financial crisis... 

It's a good question, but we believe it comes back to investors discounting rate normalisation and forecasting an end to increasing regulation (at least over the next four years) under the Trump administration.

JPMorgan Chase weekly share price
JPMorgan share price
Source: Saxo Bank 

JPMorgan Chase is expected to deliver ROE of 10.2% in FY17, increasing to 11.1% in FY18 – so higher than most of its peers. Goldman Sachs is expected to deliver higher ROE, but only in FY17 due to the cyclicality of capital  markets benefitting this year from Fed's actions. 

Given that JPMorgan has estimated cost of equity at around 10.7%, does it then makes sense that the stock is valued at 1.35x price-to-book?

Historically speaking it's definitely a stretch, but JPMorgan has always maintained a premium to peers for its more diversified and robust business on top of the industry's strongest balance sheet. 

Our quant model scores JPMorgan slightly above average. The only two factors weighing on the bank's total score are its valuation and lower yield to investors compared to the industry.

FICC in focus for Citi

Analysts expect Citigroup to deliver Q1 EPS $1.24 up 13% y/y and net revenue of $17.8B up 2% y/y. The lower expected net revenue growth compared to JPMorgan goes back to Citigroup's larger footprint in emerging markets where sentiment is just coming back following the shock from the stronger USD and the concerns over Chinese growth back in late 2015. 

The big upside surprise factor, if it materialises in Q1, is definitely its FICC segment accounting for 19% of the top-line; the segment is also around four times larger than Citi's equities business. 

Investors will focus on Citigroup's recent purchase of the Costco card business as it should most likely help offset lower mortgage revenue. 

Our quant model is more negative on Citigroup compared to JPMorgan driven primarily by its much lower yield compared to the industry.

Citigroup weekly share price
Citigroup share price
Source: Saxo Bank 

The table shows all the most important earnings releases next week including their estimates.

Top earnings releases
Source: Bloomberg and Saxo Bank 

— Edited by Michael McKenna

Peter Garnry is head of equity strategy at Saxo Bank


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