Synchrony Financial: The Overhang That Is

Summary

• Synchrony is not renewing its long-standing partnership with Walmart so investors are concerned about what this may mean for the company's long-term business prospects.
• The loss of Walmart will have an impact and will likely be an overhang through mid-2019 but I do not believe that this means that Synchrony is a sell.
• I plan to stay long the stock, do you?

Synchrony Financial (NYSE:SYF) has been in the news a lot lately. First, Warren Buffett's Berkshire Hathaway (BRK.A)(BRK.B) announced that it took a stake in the private-label credit card company and then, more recently, Walmart (WMT) announced that it decided to go with Capital One (COF) over Synchrony after years of being a partner. The Berkshire announcement was obviously positive news for Synchrony and its shareholders but, as you can expect, the stock has been under pressure since the Walmart news hit the wire.

SYF data by YCharts

As shown, the stock has been punished since Synchrony announced that it was not going to renew its contract with Walmart on July 26, 2018, but I believe that there are still reasons to remain long SYF.

The Overhang That Is

The Walmart deal will definitely be an overhang for Synchrony's stock through at least mid-2019 but it is encouraging that management is already focused on life without having Walmart in the fold. Management laid out two strategic options that Synchrony has once the WMT deal expires in 2019:

The two highlights are the most important takeaways for Synchrony and its shareholders. During the conference call, management spent a considerable amount of time explaining the potential impact of the contract loss (i.e., there are moving pieces that won't be known for some time) and, while losing a top customer is never ideal, it appears that not renewing the Walmart partnership simply made business sense for Synchrony. I believe that Ms. Margaret Keane, CEO, said it best during the conference call:

Last year we began discussions with Walmart about renewing our relationship. Although we competed aggressively to renew the program, we were unable to reach terms that would have made economic sense for our company and our shareholders. Instead we will focus on opportunities in other areas of our business where we see significant potential for growth at more attractive risk adjusted returns over time. This is consistent with our disciplined approach to managing our business for the long-term.

Let me be clear, Synchrony not renewing the contract with the largest retailer is by no means a bullish development but I do believe that the company still has strong business prospects with or without having the Walmart contract. Moreover, Synchrony also recently finalized its deal with PayPal (PYPL) - a deal that I previously described as a "game-changer" - which should be a significant growth driver for years to come. Therefore, even after considering the Walmart contract overhang, I believe that Synchrony is worthy of investment dollars.

There Is More To The Story

On July 27, 2018, Synchrony reported Q2 2018 results that beat on the bottom-line but that missed the consensus net interest income ("NII") estimate. The company reported Q2 2018 net earnings of $696M (or $0.92 per diluted share) on NII of $3.7B, which both compare favorably to the financial results that were reported in the same period of the prior year.

From a top-line perspective, the growth was largely fueled by increases in interest and fees on loans from across Synchrony's three platforms.

From an earnings standpoint, the company benefited from three key factors - lower Retailer Share Arrangements (or RSA), lower provision for loan losses, and a steep decline in the provision for income taxes (a direct result of tax reform).

The main takeaway from the operating results, in my opinion, is the fact that Synchrony's asset quality metrics appear to be finally starting to level off.

While the quality metrics are still nothing to brag about, it appears that the worst may finally be behind the company (obviously barring any significant meltdown in the economy). Moreover, as I previously described, the asset quality concerns need to be continuously monitored by investors but I do not believe that they change the investment thesis, at least at this point in time.

Synchrony's top- and bottom-line financial results were promising but the noise from the overhang will likely impact the stock well into 2019. However, let's remember that SYF shares are not priced for perfection so the Walmart contract alone is not a good reason to jump ship just yet.

SYF PE Ratio (NYSE:TTM) data by YCharts

It definitely makes it easier to stay long after considering the fact that SYF shares are trading below 12x trailing earnings, while the broader market is trading at/near all-time highs.

Bottom Line

The Walmart contract will indeed be an overhang until mid-2019 but I do not believe that investors should just throw in the towel on this private-label credit card company. The PayPal deal should help with the near term headwinds and I have faith that Synchrony's management team will be able to pivot over the next few quarters. At the end of the day, Synchrony has more going for it than just the contract with Walmart.

As a potential kicker, I believe that it would be an extremely bullish sign if Warren Buffett and team added to their position at current levels. Plus, Synchrony already has a sizable buyback program in place - $2.2B which represents approximately almost 10% of the company's total market cap - and the board recently approved another quarterly dividend increase (to $0.21). Therefore, management is paying you to be patient.

There will be plenty of moving pieces that investors will need to factor in as Synchrony enters fiscal 2019 but, in my opinion, long-term investors should treat pullbacks as buying opportunities.

Author's Note: All images were taken from Synchrony's Q2 2018 Earnings Presentation, unless otherwise stated.

Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.

Disclosure: I am/we are long SYF, BRK.B. 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.