Bank One Shares May Be Floating on Thin Air

The stock price assumes finance whiz Jamie Dimon has fixed all its woes. However it's too early to make that call

By Margaret Popper

Against the backdrop of the bear market, financial-services stocks haven't done so badly in 2001. It's true that Standard & Poor's financial-services index has dropped about 10% year-to-date, but that beats the S&P 500, down 12% so far this year.

Many money managers believe banking stocks offer a comparative haven in an otherwise turbulent market. At least their stock prices are deteriorating more slowly than those of the broader market. That's due to banks' unique fundamentals. Their cost of capital drops with each new Federal Reserve rate cut, and that's good for earnings. They offer a service consumers can't do without, even in a recession. If you're worried about the state of the economy, you might not buy that new PC your kid has been coveting, but you're not going to close your bank account.

But all banks are not equal -- although the market sometimes fails to distinguish between them with the degree precision it should. One stock that has benefited unfairly from the banking sector's good health is Bank One (ONE ). The problem is that while Bank One has made great strides in cleaning up its balance sheet over the past year, it has yet to prove that it can deliver top-line growth over time. So, for investors who want exposure to financial services, it might be wise to use a vehicle other than Bank One, at least for the time being.

As one of the major U.S. regional banks, it still faces a variety of potential problems, according to Tom McCandless, analyst at CIBC World Markets. The company will be hard-pressed to meet analysts' expectations for 2001. "The stock is trading ahead of its fundamentals," says McCandless.

STAR QUALITY.

  Bank One is currently trading at around $34 a share for a price-to-estimated 2001 earnings per share of 13.53. That's just a little more than one times projected earnings growth for 2001. When you consider that Bank One's better-run competition, Citigroup (C ) and Wells Fargo (WFC ), are trading at almost identical multiples of similar earnings-growth estimates, you have to wonder if Bank One isn't out of its league. Both Citi and Wells Fargo have far more revenue growth potential than Bank One, and their balance sheets are much stronger than Bank One's.

One of the main reasons Bank One's stock seems able to defy gravity is Jamie Dimon, the bank's current chairman and CEO, who came from Citigroup a year ago. Dimon was chairman of Citi's Salomon Smith Barney investment banking operation. As a protégé of Sandy Weill, the legendary Citigroup chairman, Dimon gets considerable respect in industry circles as a cost-cutter. And he is already working his magic at Bank One. "We cut 6,000 to 7,000 people last year," points out Charlie Scharf, Bank One's CFO, who also earned his stripes at Citi.

Dimon has not restricted himself to chopping heads -- he has also made a concerted effort to shore up Bank One's ledger. In the fourth quarter of 2000, he increased its loan-loss reserve by $1 billion, to 2.36% of the bank's total, and added an additional $225 million to the reserve for auto-lease residual losses. As a result, Bank One had a fourth-quarter loss of $512 million, which led to a loss for the year of $511 million.

FAREWELL, CONSULTANTS.

  The idea is that having swallowed all its bad-tasting medicine, Bank One is now a happy, healthy institution poised for growth. "We've got a company with great franchises," says Scharf. "We've been trying to spend 2000 fixing our problems so that, in 2001, we're positioned with a clean company." But it's still not entirely clean from a cost perspective. Even Scharf acknowledges there is further cost-cutting to do. "In the short term, we have to cut costs," he adds. "If you're not the low-cost provider in financial services, you can't compete."

Bank One says it can wring $500 million out of annual costs by controlling its consulting habit. Last year, the bank spent $1.5 billion on outside consultants. This year it'll spend under $1 billion, and cut $150 million of communications and transportation expenses -- easily achieving its $500 million savings. That's despite having to spend $150 million to meld the processing systems it inherited when First Chicago NBD and Bank One merged to create the new Bank One in 1998. By slashing overall costs and increasing productivity with judicious spending, the bank hopes to achieve a return on equity of 15% to 17% in 2001, and 18% to 20% eventually, according to Scharf.

All well-intentioned, good-sounding stuff, but investors might want to be wary of the idea that Bank One is safely out of the woods. "You can't get there simply by cutting costs," observes CIBC's McCandless. "They don't have any growth plans. They're losing market share every day, morale is bad, and personnel turnover is up."

KEY ASSUMPTIONS.

  One of the biggest problems Bank One faces is getting its main franchise areas -- Ohio, Indiana, Illinois, Michigan, Wisconsin, Iowa, Colorado, Texas, Arizona, Louisiana, and Oklahoma -- to yield revenue growth during what could be shaping up as a longer and deeper-than-expected economic downturn. "Bank One has exposure to possibly every area of credit concern in the country," says McCandless. "And they're big in leveraged lending and telecoms." These are two areas where credit quality is particularly prone to deterioration given the current slowdown.

Not that Dimon & Co. are unaware of potential problems. In his guidance to Wall Street concerning 2001 earnings, Dimon said he was comfortable with the lower end of consensus estimates -- around $2.70 per share. "That's assuming that credit-card defaults don't get worse from here, or consumer losses on the real estate portfolio, and that commercial lending declines, but not to the level it would in a full economic recession," says CFO Scharf.

In the current economic climate, all these conditions may be a lot to ask for. "The stock jumped the gun, assuming that all the company's fixes will work," says Stephen Biggar, a financial-services analyst at Standard & Poor's, a unit of The McGraw-Hill Companies (as is BusinessWeek Online). "If [Bank One] does come through with perfection, then the stock is fairly valued."

TRUE BELIEVERS.

  But Biggar isn't expecting perfection. He can't see the company coming in at the Street's consensus of $2.66 earnings per share for 2001. "If you take the optimistic view, they should come in at around $2.40," he says. "The stock has been trading at a premium multiple given that it has had no earnings progress for the past two years." Biggar figures it's worth $28 to $30 a share. That's at the low end of the range of analyst opinion, which puts the 12-month target price in a range from $27 to $45.

But the aura of Jamie Dimon and expectations about what he might be able to accomplish have so far kept the stock from tanking. "Bank One has become a cult stock without the track record," says CIBC's McCandless. One step toward establishing that track record will be the company's first-quarter earnings announcement on Apr. 17, when the Street consensus says it should hit 59 cents earnings per share. But even if Bank One does hit its target, investors would do well to see a few more quarters of proof before buying into the idea that Bank One's makeover is complete and successful.

Popper covers the markets for BW Online in our daily Street Wise column

Edited by Beth Belton