Synchrony Financial: Risks Remain But The Latest Move Down Was Overdone

Summary

• Synchrony Financial's stock has not performed well so far in 2018 and the uncertainty related to the Walmart deal is not helping.
• However, the company continues to report impressive operating results and the most recent quarter was more of the same.
• I am long Synchrony Financial and I recently added to my position.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Get started today »

Synchrony Financial (NYSE:SYF) recently reported strong Q3 2018 results that beat the top- and bottom-line estimates. The market, however, was not impressed as shown by the fact that the stock was down by almost 10% since the earnings were released (yes, the broader market pullback also came into play).

More recently, the stock took another leg down when it was announced that Walmart (WMT) was suing Synchrony over disputes related to the WMT credit-card portfolio.

SYF data by YCharts

Notice the earnings-related and WMT-related drops over the last two weeks. While there are definitely risks that need to be considered, I believe that the recent pullback in SYF shares was overdone and that Synchrony Financial is still worthy of investment dollars, at least for the time being.

The Walmart News, A Case Of Addition By Subtraction?

In July 2018, Walmart decided to drop Synchrony and go with Capital One (COF) for the servicing of its credit cards. Synchrony's management team acknowledged the fact that losing Walmart's business would definitely negatively impact operating results in the near-term but they also stressed the importance of making a decision that is in the best interest of the company's long-term business prospects. There is a ton of moving pieces to consider but management previously provided two strategic options that are being evaluated:

Source: Q2 2018 Earnings Presentation

During the Q3 2018 conference call, management again mentioned that Synchrony should be able to replace the EPS that is associated with the WMT portfolio. It is looking more likely that a breakup is coming and that a portfolio sale will occur and, as described above, there will be a significant amount of capital that can be allocated to other things (i.e., investing in its business and/or buying back stock).

A Synchrony-Walmart breakup may turn out to be a case of addition by subtraction for the company and its shareholders. Remember, all growth is not healthy growth.

Let's also remember that Synchrony has been expanding its relationship with PayPal (PYPL) over the last year. I called the latest PayPal deal a game-changer and, in my opinion, there is a lot more going for Synchrony than just a deal with Walmart (of course, this thought process could change if additional partnership losses are announced in the months/quarters ahead).

The Latest, Strong Financial Results From Top To Bottom

On October 19, 2018, Synchrony reported adjusted Q3 2018 EPS of $0.91 (beat by $0.10) on revenue of $4.21B, which compares favorably to the financial results from the year-ago quarter.

Not only did Synchrony beat top- and bottom-line estimates but the company also reported strong growth metrics across its business platforms.

And more importantly, especially given the stage of the business cycle that we are in, Synchrony's asset quality metrics are finally starting to level off.

This asset quality topic has been front-of-mind for a while now and, as I previously described, I do believe that the risk profile for the company has increased over the last four quarters due to deteriorating asset quality metrics but, in my opinion, Synchrony is still well-positioned to prosper in the changing retail space. Additionally, I believe that shareholders should be encouraged by the improvements that have been made so far in 2018. But, investors should definitely continue to monitor these metrics in the quarters ahead.

It also helps the bull case that SYF shares are trading at a deep discount when compared to its peers.

Valuation

Synchrony's stock is attractively valued when compared to its peers.

SYF PE Ratio (TTM) data by YCharts

The Walmart deal may turn out to be a bigger impact than current projections but, in my opinion, the selloff is overdone.

Risks

Synchrony Financial's asset quality concerns could come back into focus in 2018 and the bull case would definitely be negatively impacted if this were to happen. The company's charge-off rates have been creeping higher over the last year but I do not believe that this is a major risk, at least at this point in time. I would, however, closely monitor Synchrony Financial's asset quality metrics through at least 2019.

Lastly, additional key partnership losses would have a significant impact on Synchrony's business prospects.

Bottom Line

An analyst recently downgraded SYF shares (price target was reduced to $26 from $32) due to the uncertainty related to the Walmart deal, but there are now rumors that Synchrony could also potentially lose the Sam's Club deal. And of course, some pundits are already jumping to the conclusion that other key partners could also potentially jump ship. It makes sense that analysts are worried about Synchrony losing the Sam's Club deal but, in my opinion, it is a little premature to think that the other partnerships are now all of the sudden at risk.

To be clear, the risk level for Synchrony has materially increased but, in my opinion, this company is well-positioned for 2019 and beyond. Let's also remember that Synchrony has a solid dividend and management continues to show that they run a shareholder-friendly company (repurchased $966M worth of its shares during the most recent quarter). As such, long-term investors should seriously consider adding SYF shares on pullbacks.

Author's Note: All images were taken from Synchrony Financial's Q3 2018 Earnings Presentation, unless otherwise stated.

Disclaimer: Synchrony is a core holding in the R.I.P. portfolio and I have no plans to reduce the position in the near future.

Additional 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. 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.