- Shares in Ally Financial have bounced back nicely since their COVID-19 meltdown lows.
- However, the stock still trades under adj. tangible book value and yields almost 3.3% with some recent insider buying.
- A full investment analysis follows in the paragraphs below.
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A wise man can learn more from a foolish question than a fool can learn from a wise answer."-Bruce Lee
Exactly one month ago, Ally Financial (NYSE:ALLY) was added to the model portfolio at The Insiders Forum. The stock rose some 50% since then. The market has continued to have a fantastic rally over that time as well on optimism around the economic restart happening across the country on a region by region basis.
S&P 500 incredibly moved into the black for the year. S&P 500 profits projected by FactSet to be down more than 40% in the second quarter of this year. That is the biggest decline since the financial crisis. That is one of many reasons we think the market is due for a least a bout of significant profit taking as we articulated in a piece posted yesterday.
We are doing very little buying in this market, content to let our covered call positions expire in the money the third Friday of every month on option expiration day. Most stocks and sectors in the market feel overbought here. However, Ally still sports more than reasonable valuations on a 'normalized' basis. We update our investment thesis on it to reflect additional data over the past month in the paragraphs below.
Ally Financial is a Detroit headquartered bank holding company, providing car finance, online banking via a direct bank, corporate lending, vehicle insurance, mortgage loans, and an electronic trading platform. With $180.6 billion in assets, $120.8 billion in deposits, and ~4 million retail bank accounts at YE19, Ally ranked as the 18th largest bank in the U.S. Known as General Motors Acceptance Corporation until 2010, the company has roots dating back to 1919. Owing to the recent shutdown of the economy, its shares took a beating earlier this year. Even with the recent rally, they are still down a tad over 30% from their 52-week highs.
The bank's business model is similar to Discover Financial Services (DFS), where it borrows money from depositors through its branchless (internet) banking arm and then initiates consumer loans - except with Ally, instead of credit cards, it specializes in automobile purchase and lease transactions. These installment sales contracts and operating leases are originated by auto dealers and then sold to Ally. The bank's Automotive Finance subsegment generated $4.4 billion of total net revenue in 2019 on assets of $113.9 billion at YE19, representing 69% and 63% of its totals, respectively. Ally also sells insurance and vehicle service contracts through its auto dealer network, accounting for 2019 net revenue of $1.3 billion or 21% of total. The balance of its top line is primarily generated through retail mortgages and loans to middle-market companies owned by private equity sponsors.
By most metrics, 2019 was an excellent year for Ally. On an adjusted basis, the bank earned $3.72 a share on total net revenue of $6.3 billion, representing 12% and 5% increases over the prior year. Its retail auto portfolio yielded 6.60%, up 46 basis points from 2018, while its charge-off rate dropped 4 basis points to 1.29%. Insurance premiums rose 12% to the aforementioned $1.3 billion. S&P and Fitch both upgraded Ally's senior unsecured credit rating to investment grade. The bank increased its quarterly dividend 13% to $0.17 a share while Adj. tangible book value per share increased 12% to $35.10 at YE19. As a result of these accomplishments, investors were rewarded with 35% share appreciation.
Also, in October 2019, Ally closed on the acquisition of Credit Services Corporation, a digital point-of-sale payment provider that offers financing to consumers for various healthcare procedures for $177 million cash.
That deal was followed by an announcement of an agreement to purchase sub-prime credit card and consumer finance concern Cardholder Management Services (CardWorks) in February 2020. At the time the deal was announced, total consideration was valued at $2.65 billion, consisting of $1.35 billion in cash and 39.5 million shares of ALLY, valued on February 14, 2020, at $1.30 billion. Although the transaction is anticipated to close in 3Q20, Ally can pull the plug on the deal without incurring a penalty.
The Street was expecting another strong year out of Ally, forecasting 13% Adj. EPS growth to $4.22 a share in 2020 at the onset of the year. The bank appeared to be on track with auto loan application volume up 5% in January and February as compared to the same period in 2019. That trajectory has since changed significantly with the bank seeing application volume cratering ~50% during the shutdown. Overall, Ally generated $9.1 billion of consumer auto originations at a 7.25% originated yield in 1Q20, while its net charge-off rate increased 12 bps to 1.44%. These metrics were solid when compared to the non-coronavirus 1Q19 output of $9.2 billion of auto originations at a 7.56% originated yield.
Ally proactively offered its customers loan forbearance, of which 1.1 million auto customers, or ~25%, accepted. Of this population, 70% have never been delinquent with Ally.
Predictably, its written insurance premium volumes also declined sharply in March but were still up 4% year-over-year to $317 million. Also unsurprisingly, the bank saw a spike in mortgage refinancings and a hard uptick in revolver draws at its corporate finance segment. Ally did manage to add 71,000 new retail deposit customers in the quarter - pushing that total above 2 million - while increasing total deposits (retail and corporate) ~$9.0 billion to $122.3 billion. The net effect of all these dynamics was a 1Q20 Adj. EPS loss of $0.44 on Adj. net revenue of $1.6 billion versus a gain of $0.80 a share on Adj. net revenue of $1.5 billion in the prior-year period.
Considering the Street was estimating 1Q20 Adj. EPS near $1.00 a share at the start of 2020, a $0.44 per share loss was a bit of a jolt. However, most of the shortfall reflected a higher provision for credit losses, the accounting for which underwent a significant change beginning on January 1, 2020. This transformation was done in response to the banking crisis of 2007-2010, compelling lenders to forego a backward-looking approach - known as incurred loss - for a forward-looking measure called current expected credit loss [CECL] beginning January 1, 2020. CECL requires a bank to increase its loss provisions starting in the quarter the loan is made. Ceteris paribus, a rise in a bank's loan losses will result in it reporting lower regulatory capital ratios, which reduces its capacity to lend while remaining in compliance with regulatory capital rules. In addition to front-end loading loss reserves, CECL forced banks to create complicated models to forecast future provisions. In March 2020, U.S. banking agencies allowed banks the alternative to delay the impact of CECL on regulatory capital, which Ally elected. The total deferred impact on Common Equity Tier 1 capital related to its adoption of CECL was $1.2 billion.
Either way, those models certainly did not consider the massively ambiguous COVID-19 ramifications back in January. Ally's 1Q20 results included a $903 million provision expense, up $624 million (~$1.67 per share) from 4Q19. In other words, pre-COVID provision, the bank earned $1.23 a share on an Adj. basis. This provision also had the effect of knocking Adj. book value per share to $32.80, down from $35.10 at YE19. Without the CECL provision expense, this metric would have been $35.50.
Putting this revision into further perspective, before CECL on January 1, 2020, the bank reserved $1.1 billion or 1.49% of its retail auto portfolio. With the implantation of CECL, that reserve grew to $2.4 billion, or 3.34% of total auto loans. Owing mostly to COVID-19 impacts, reserves jumped to $2.8 billion, or 3.91% of total. However, the company only anticipates net-charge offs to rise to a range of 1.8-2.1% for FY20. In other words, future provisions should be relatively moderate.
Balance Sheet & Analyst Commentary:
Ally and its banking subsidiary were on a very solid financial footing with Common Equity Tier 1 Ratios of 9.27% and 12.00% (respectively) versus the minimum requirements of 4.5%. The bank had total liquidity of $30.1 billion, and although it did issue $750 million of 5.80% senior notes due 2025 in April 2020, its major funding source continues to be customer deposits, which account for 75% of its funding.
The bank had been an aggressive repurchaser of its own stock, buying back ~124.8 million shares, or ~23% of all shares outstanding, since 3Q16 as of the end of the first quarter. However, given the uncertain environment, Ally elected to suspend its buyback in 1Q20 through the end of June 2020. It did raise its quarterly dividend 12% to $0.19 in January 2020, for a noteworthy current yield of approximately 3.3%.
The Street is a mixed bag on Ally's prospects, featuring three buys, three outperforms, three holds, and one sell recommendation. Predictably, price targets have been coming down, although generally from the mid-30s to the high 20s - the one exception being Cfra, who carries the lone sell rating and a $12 price target. The only recent rating change was a downgrade by BTIG Research from a buy to a hold after the bank's earnings release of April 20th. A few days ago, Morgan Stanley reissued its Buy rating and $26 price target. The analyst there noted a recent JD Power survey that showed retail auto sales for the last week in May only fell 12% from a year ago. This is certainly a marked improvement from the almost 60% drop encountered in the last week of March.
Board member Mayree Clark has used the recent downdraft as a buying opportunity, purchasing 15,000 shares at $14.25 on April 24th. Two other board members bought nearly 23,000 shares in mid-March around $20 a share.
It is not too often that an investor has the opportunity to purchase a well-run large financial institution at a significant discount to Adj. tangible book value. However, these are not normal times. On a normalized basis, Ally is trading at less than 6x's 2020 earnings pre-coronavirus outlook. With the front-end loaded write down in 1Q20, any future provision expenses will likely be less significant going forward. With the Federal Reserve and the federal government providing seemingly unlimited liquidity to back up the banks and the economy, Ally's current share price represents a still solid buying opportunity. However, after the rally in the market in the stock as well as the market over the past month, I would slowly accumulate this name on down days and/or via covered call positions.
The shape of the recovery from the unprecedented shutdown of the worldwide economy is still uncertain but is looking more and more encouraging over the past month. The doubt concerning the state of CardWorks and the deal - from which it would be better served to walk away from now - have added additional investor angst. But the bet here is that the insiders are correct, and shares of ALLY will be trading near tangible book value - still near $30 - in 12-18 months.
Talk sense to a fool and he calls you foolish.'- Euripides
Bret Jensen is the Founder of and authors articles for the Biotech Forum, Busted IPO Forum, and Insiders Forum
Author's note: I present an update my best small and mid-cap stock ideas that insiders are buying only to subscribers of my exclusive marketplace, The Insiders Forum. Try a free 2-week trial today by clicking on our logo below!
This article was written by
We are a team of analysts led by Bret Jensen, Chief Investment Strategist at Simplified Asset Management.
We run the investing group The Insiders Forum where we specialize in small and mid-cap stocks that insiders are buying. The Insiders Forum portfolio managed by Bret Jensen consists of 12-25 top stocks in different sectors of the market that are attractively valued and have had some significant and recent insider purchases. Our goal is to outperform the Russell 2000 (the benchmark) over time.
Analyst’s Disclosure: I am/we are long ALLY. 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.
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