Synchrony: Asset Quality Is A Risk But It Is Not A Showstopper
Summary
- SYF shares are down ~30% on a YTD basis.
- The company's asset quality is a concern, but it is already baked into the current stock price.
- SYF is a long-term buy at today's price.
Synchrony Financial's (NYSE:SYF) stock price took a big hit when the company reported disappointing Q1 2017 results, and SYF shares are still down double digits since the financial results were released.
(Source: Nasdaq)
The company's Q1 2017 EPS of $0.61 missed the consensus bottom line estimate by ~16%, but, more importantly, Synchrony's earnings were down by $0.09, or ~13%, YoY. The Q1 2017 earnings were negatively impacted by a buildup of reserves and there is no denying that Synchrony's asset quality is a near-term concern, but I believe that Synchrony is still worthy of your investment dollars.
Synchrony Is Attractively Valued, Even After Factoring In An Additional Reserve Build
The management team has shown the ability to grow Synchrony's business since going public in mid-2014, as the company's net interest income, after retailer share arrangements has increased from $8.7b to $10.6b over the last two years.
(Source: 10-K)
There are several factors contributing to Synchrony's impressive top line growth but one of the biggest factors, in my opinion, is management's proven ability to outperform the market in a growing industry. To this point, management provided a few slides during the Q1 2017 Investor Presentation that shows the areas where Synchrony has been one step ahead of its peers.
Synchrony's past results have been impressive and the company's growth prospects are encouraging when looking out over the next few years, but that does not mean that it has been smooth sailing for this private-label credit card company, especially over the last two to three quarters.
Synchrony's asset quality issues have been highlighted over the last year and they are largely related to relaxed underwriting requirements from prior years but the company has recently emphasized the importance of maintaining a disciplined underwriting approach. As a result, the company has improved the quality of its portfolio over the last few fiscal years.
(Source: Synchrony's Q1 2017 Investor Presentation)
As shown, the portfolio is more levered to high quality accounts and the under/equal to 600 FICO scores have stayed around 8% for an extended period of time. Investors must also consider one important point, Synchrony has experienced significant growth in its portfolio (and top line revenue) so the 34% of 721+ accounts at Q1 2017 represents a significantly higher balance in absolute terms (i.e. the company has improved the quality of the portfolio while also growing the balance).
So, yes, asset quality is a concern but I believe that it is priced into the stock as SYF shares are currently trading close to a 52-week low. Let's look at some numbers. Based on trailing earnings and forward earnings estimates, Synchrony is attractively valued when compared to its peers.
SYF PE Ratio (TTM) data by YCharts
Synchrony's forward earnings estimates are currently being called into question, and rightfully so, as further deterioration of the company's asset quality could have a significant impact on the bottom line. So, let's try to get a clearer picture of what the next two years may look like for Synchrony. On May 19, 2017, an analyst from Wells Fargo downgraded the whole credit card sector on the expectation that net charge-offs would be rising. The analyst estimated that increases in provisions (100bps) could have a big impact on EPS estimates for these companies, and he provided the following assumptions for the major players:
- EPS impact for Discover (NYSE:DFS) and Synchrony would be in the range of 22%-23%.
- EPS impact for American Express (NYSE:AXP) would be 15%.
Using the analyst's assumptions for potential impacts to earnings, in addition to the current year EPS estimates per Yahoo! Finance, I came up with the following adjusted price-to-earnings ratios.
| 2017E EPS | 2018E EPS | Adjusted 2017E EPS* | Adjusted 2018E EPS* | ||
| Discover | $6.02 | $6.67 | $4.67 | $5.17 | |
| P/E Ratio | 12.82 | 11.57 | |||
| American Express | $5.69 | $6.31 | $4.84 | $5.36 | |
| P/E Ratio | 16.02 | 14.44 | |||
| Synchrony | $2.60 | $3.19 | $2.02 | $2.47 | |
| P/E Ratio | 13.58 | 11.07 |
(Source: Data from Yahoo! Finance; table created by W.G. Investment Research)
*Adjusted the 2017 and 2018 EPS estimates by using the assumptions noted above [i.e. reduced DIS & SYF earnings by 22.5% (middle of the range) and AXP by 15%].
The takeaway is that Synchrony would still be attractively valued when compared to its peers, even after factoring in a 22.5% cut to expected earnings. Moreover, the overall market is trading at all-time highs so Synchrony would be very attractively valued when compared to the broader market at a P/E ratio well-below 14. Plus, let's not forget that Synchrony could actually come out of this anticipated downturn in asset quality somewhat unscathed, which would make SYF shares an absolute steal at today's price.
Bottom Line
It is easy to get caught up in the asset quality concerns for the credit card industry but I believe that a slight downturn - mid-single digit to low teens impact to earnings - is already baked into the company's stock price. By no means do I think that Synchrony will come out of this period of time without having any type of impact to earnings, but it appears that the company is in a position to create a lot of shareholder value over the next two plus years.
Additionally, Synchrony's board recently approved an increase to the company's quarterly dividend (from $0.13 to $0.15) and upped the buyback program to $1.64b (represents over 7% of the outstanding shares based on the current stock price).
Shareholders should definitely treat Synchrony's reserve build as a concern that has the potential to derail the company's story; however, I would recommend for investors with a long-term prospective to consider adding shares at today's price but also keep this company on a short leash through 2018.
Full Disclosure: I recently added to my SYF position in the R.I.P. Portfolio while shares were trading slightly above $28.
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Disclosure: I am/we are long SYF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.