Synchrony Financial: All-In On The U.S. Consumer

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About: Synchrony Financial (SYF), Includes: AXP, COF, DFS
by: BOOX Research
Summary

SYF has been a big winner this year up 45% on resilient growth and strong earnings, defying skepticism of exposure to consumer credit.

Stock trades at a discount to credit-services industry peers which may be justified given lower quality asset portfolio and higher implied risks.

Stock has more upside if the U.S. economy can avert a recession and credit conditions remain stable.

Synchrony Financial Inc. (NYSE:SYF) partners with retailers to offer consumers store branded credit cards along with a business segment for healthcare related financing. The stock has been one of the big winners in the financial sector this year, up 45% year to date. The strong performance rebounded from a steep decline in 2018 when concerns grew over the lending portfolio credit quality combined with a macro outlook of rising interest rates. Resilient growth, better than expected earnings, and a number of new partnership announcements this year have helped to improve investor sentiment. This article covers the investment thesis for Synchrony Financial and why I'm bearish on the stock. My observation is that trends in the company's asset credit quality continue to be poor and have actually deteriorated this year. SYF trades at a discount to its peers in the credit-services industry which I believe to be justified given higher implied risks at this stage in the market cycle.

SYF stock price chart. source: FinViz.com

Higher Risk.. Higher Reward?

Among large cap credit services companies, Synchrony Financial has less diversification away from consumer credit cards compared to peers like Capital One Financial Corp (COF), Discover Financial Services (DFS), and American Express Co (AXP). While each of these comparables have different operating models, the data below shows that when just comparing credit card segments, SYF has a lower quality asset portfolio with higher delinquency rates and a higher net charge off rate from the industry.

Credit Card Credit Metrics +30 day delinquency +90 day delinquency Net Charge Off Rate

Credit Cards % of Assets

Synchrony Financial (SYF) 4.92% 2.51% 6.06% 96%
Capital One Fin. (COF) 3.72% n/a 4.90% 45%
Discover Financial (DFS) 2.45% 1.26% 3.50% 80%
American Express (AXP) 1.50% 0.60% 2.80% 72%

Investor Relations. source: SYF, Capital One, Discover and American Express.

In Q1 Synchrony Financial reported a +30 day delinquency rate among credit card accounts at 4.92%, which was higher than the other companies. Separately, the net charge off rate at 6.06% was higher than the average for all commercial banks as reported by the Federal Reserve which averaged 3.69% for Q1. The net chart off rate is the percentage of loans that a company believes it will never be able to collect from lending receivables. AXP has industry leading asset quality given its business model of catering to the premium card market and higher rated borrowers. AXP also has a large corporate spending accounts segment which has less risk than consumers. COF is closer to a traditional bank within the group with a smaller percentage of assets in credit card loans at ~45% compared SYF at 96%.

The other part of this story is that delinquency rates for SYF have "slipped" in recent quarters. What's curious about the charts below is the use of a poorly scaled y-axis to represent the trend in asset quality metrics. At first glance, they almost appear to be straight lines of stability, but in-fact show a deterioration in metrics. 30+ days past due loan receivables at 4.92% in Q1 2019 was up 75bps from Q2 2018. Net charge-offs of 6.06% in Q1 was up 109bps from 4.97% in Q3 2018. The trend here is the most concerning aspect of the investment thesis and why I would avoid this stock.

SYF credit quality metrics. source: Q1 investor presentation

SYF Discount to Peers

The difference in asset credit quality is one reason why SYF trades at a discount to peers in terms of price to earnings. SYF has a forward PE ratio of 7.7, below COF at 8.2, DFS 9.0, while AXP commands a premium to the group at 15.3.

Chart Data by YCharts

Another important metric that helps explain why SYF is relatively 'less expensive' is return on equity. Over a trailing twelve month period, SYF ROE of 22.6% was below DFS at 26.8%, and AXP at 32.1%. Capital One has a larger traditional banking business that's indicative of the lower ROE at 11.9% as per below.

Chart Data by YCharts

The table below summarizes some key valuation metrics. SYF favorably has lower financial leverage compared to DFS and AXP, with a debt to equity ratio of 1.5 , and also presented higher revenue growth in Q1 at 10.2%. It's worth noting that SYF has the highest forward dividend yield at 2.5%

Investment Thesis

SYF is doing something right as loan receivables and earnings are up strongly over the past year. The company made a profit of $1.107 billion in Q1 representing $1.56 in EPS, up from $0.83 from the period last year. In May the company announced a share repurchase program of up to $4 billion and a dividend increase to quarterly rate of $0.22 per share from 21 cents.

SYF retail partnerships. source: Q1 investor presentation

The company has expanded partnerships including managing store cards for some major retailers. This week the company announced that was introducing a secured credit card with Amazon Inc (AMZN) for consumers with low credit score which requires a deposits helping to mitigate risks. This news is seen as another growth opportunity but also reinforces my view that the company is stretching as it reaches down the credit curve.

SYF retail partnerships. source: Q1 investor presentation

Analysis

The question of whether or not to invest in SYF for me comes down to one question; will the U.S. economy enter a recession in the near future? Considering that credit cards are among the riskiest loan types and SYF is highly exposed to trends in consumer credit, the stock faces significant potential downside should an economic downturn materialize. A scenario of rising unemployment could lead to higher delinquency rates and consumer credit defaults, materially impacting SYF financial results. Recently weak employment numbers in June and signaling by the FED that they are ready to cut rates should growth continue to be sluggish suggests the risks are rising for a recession. Indeed, the implied probability of a U.S. recession by May 2020 as predicted by the treasury spread is approaching 30%. Since the 1960's such conditions have nearly always preceded a recession, but its a point open for debate if in-fact this time is different.

source: NY FED

On the other hand, the severity of a potential downturn or actual realized loan losses for SYF in such an event is unknown. If the U.S. can avert a contraction in the credit cycle SYF could also have enormous upside defying the current bearishness already priced into the stock. It's entirely possibly the U.S. economy strengthens from here going forward. This is just not a bet that I'm willing to make with Synchrony Financial.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.