SYF - Synchrony

[rukawa]

Spinoff from GE. They offer private label credit cards...think store credit card. They trade at a 12 PE. Berkshire and Klarman have invested. I have zero opinion on this because I don't really understand it at all. But I would like to and thought it was really strange their isn't a thread on this. There is a VIC thread here:

 

https://www.valueinvestorsclub.com/idea/SYNCHRONY_FINANCIAL/140272#messages

https://www.valueinvestorsclub.com/idea/SYNCHRONY_FINANCIAL/137712

 

Gurufocus also has something:

https://www.gurufocus.com/news/554116/what-do-buffett-and-klarman-see-in-synchrony-

 

When I first saw this I stupidly thought...gee I wonder why they don't trade at 30 Pe like mastercard or visa. And the answer is that they don't have merchant fees which is the whole reason why retailers prefer them. This means there economics are significantly worse that a normal credit card company....which usually mint money.

[petec]

And the answer is that they don't have merchant fees which is the whole reason why retailers prefer them.

 

And because they take credit risk which MC and V don't do.

 

Basically they're just a nonbank lender earning a spread between borrow/lend costs.

[scorpioncapital]

Might be thought of as a way to play 2 trends:

1. inflation via increased wages leading to increased consumer spending behaviour (and increasing interest rates indirectly)

2. strangely, a diversified play on retail similar to a retail REIT, but instead of being the landlord, you are the cardlord.

 

 

[gfp]

I was watching to see if the Amazon relationship became important for them, but it seems like Amazon is dissapointed in Synchrony's handling of the 'prime store card' and has been pushing the JPM 5% Amazon card instead.  Including recently a very big marketing push all over the cash registers at Whole Foods.

 

I have and use the Amazon Prime Store Card (5% off on everything through statement credit) and the Lowes card (5% back at the register plus Home Depot will match the competitor 5% discount if you use your HD card).

 

The customer reviews are pretty bad and that won't help their relationship with Amazon grow.  Best bet for SYF is an acquisition by a big bank or COF before the next consumer credit downturn.

[jrallen81]

SYF is a big Baupost holding as of the last 13-F

[tol1]

And the answer is that they don't have merchant fees which is the whole reason why retailers prefer them.

 

And because they take credit risk which MC and V don't do.

 

Basically they're just a nonbank lender earning a spread between borrow/lend costs.

 

They have an online bank that serves for the majority of the liabilities.

 

Anyone has drilled down their earnings? Makes more sense to have a discussion based on that.

 

[NBL0303]

 

Anyone has drilled down their earnings? Makes more sense to have a discussion based on that.

 

Yes - on just an earnings basis it is quite cheap.  Especially when one accounts for the fact that they are substantially overcapitalized.  So if you take that capital out of your price/value calculations on an earnings basis - it is very cheap (relative to current elevated market valuations).  Of course there are reasons it is cheap - some of it is clearly the fears of the changing world of financial intermediation (as a previous poster referenced, especially in a world of Amazon/online dominance), some of its cheapness is also likely due to their credit losses ticking up over the 18 months or so and the concern that they would face another 2008-2009 earnings round, and some of the cheapness could still be due to spin-off effects.

[rukawa]

 

Anyone has drilled down their earnings? Makes more sense to have a discussion based on that.

 

Yes - on just an earnings basis it is quite cheap.  Especially when one accounts for the fact that they are substantially overcapitalized.  So if you take that capital out of your price/value calculations on an earnings basis - it is very cheap (relative to current elevated market valuations).  Of course there are reasons it is cheap - some of it is clearly the fears of the changing world of financial intermediation (as a previous poster referenced, especially in a world of Amazon/online dominance), some of its cheapness is also likely due to their credit losses ticking up over the 18 months or so and the concern that they would face another 2008-2009 earnings round, and some of the cheapness could still be due to spin-off effects.

 

Are they overcapitalized? If so that it implies the company is mismanaged and the bull case is that they will become less mismanaged (return cash back to shareholders) in the future. If they are not mismanaged then it implies you can't remove the excess capital from the purchase price since the cash is needed perhaps to offset future losses.

[tol1]

 

Anyone has drilled down their earnings? Makes more sense to have a discussion based on that.

 

Yes - on just an earnings basis it is quite cheap.  Especially when one accounts for the fact that they are substantially overcapitalized.  So if you take that capital out of your price/value calculations on an earnings basis - it is very cheap (relative to current elevated market valuations).  Of course there are reasons it is cheap - some of it is clearly the fears of the changing world of financial intermediation (as a previous poster referenced, especially in a world of Amazon/online dominance), some of its cheapness is also likely due to their credit losses ticking up over the 18 months or so and the concern that they would face another 2008-2009 earnings round, and some of the cheapness could still be due to spin-off effects.

 

Are they overcapitalized? If so that it implies the company is mismanaged and the bull case is that they will become less mismanaged (return cash back to shareholders) in the future. If they are not mismanaged then it implies you can't remove the excess capital from the purchase price since the cash is needed perhaps to offset future losses.

 

I would not call overcapitalized mismanaged in the spread taking / lending industry. Divis / buybacks can be raised fairly instantly anyway.

[NBL0303]

 

Are they overcapitalized? If so that it implies the company is mismanaged and the bull case is that they will become less mismanaged (return cash back to shareholders) in the future. If they are not mismanaged then it implies you can't remove the excess capital from the purchase price since the cash is needed perhaps to offset future losses.

 

I believe they are - and substantially so and it does raise questions as to why - but it may not be mismanagement so much as the circumstances of its spin-off and negotiations with various regulators involving the spin-off.

[Spekulatius]

Some things to note:

1) They don’t really own their CC customers. Their customers can pull the business upon contract expiration and move it somewhere else

2) They not own the payment network, unlike DFS or Amex. Although, they do some to have a proprietary network to facilitate payment in store terminals without going over other CC payment systems. Note that this is a real threat to Visa and MC

 

It is a cyclical business. 10% chargeoffs during last recession -outch! Even 5.8% right  now when everything is peachy seems kind of high.

[NBL0303]

 

It is a cyclical business. 10% chargeoffs during last recession -outch! Even 5.8% right  ow when everything is peachy seems kind of high.

 

Exactly - I believe this is the primary reason for its market cheapness (relative to the current prevailing market valuations) - because investors see their chargeoffs began rising and many are thus pricing in the even higher chargeoff rate reached in the last recession.  It is obviously concerning when their chargeoff rate is rising - even though the economy is still growing/thriving etc.  It is easy to imagine ugliness ahead when the economy turns and 6% becomes something higher.

[tol1]

 

It is a cyclical business. 10% chargeoffs during last recession -outch! Even 5.8% right  ow when everything is peachy seems kind of high.

 

Exactly - I believe this is the primary reason for its market cheapness (relative to the current prevailing market valuations) - because investors see their chargeoffs began rising and many are thus pricing in the even higher chargeoff rate reached in the last recession.  It is obviously concerning when their chargeoff rate is rising - even though the economy is still growing/thriving etc.  It is easy to imagine ugliness ahead when the economy turns and 6% becomes something higher.

 

This is the standard reversion to the mean argument. You have to look at their BS to understand what has changed vs 2008 and you will understand why it is an attractive investment.

[tol1]

Some things to note:

1) They don’t really own their CC customers. Their customers can pull the business upon contract expiration and move it somewhere else

2) They not own the payment network, unlike DFS or Amex. Although, they do some to have a proprietary network to facilitate payment in store terminals without going over other CC payment systems. Note that this is a real threat to Visa and MC

 

It is a cyclical business. 10% chargeoffs during last recession -outch! Even 5.8% right  now when everything is peachy seems kind of high.

 

1) Contracts are long-term and relationships even longer. What you are saying holds true for the entire industry btw.

2) SYF are issuer/bank in one. Dig deeper how they compare to the standard networks and you will be surprised regarding what level of data they get.

 

Again, merely looking at historical charge-off rates does not make any sense as the balance sheet has changed. It was 11% , not 10%.

[Spekulatius]

SYF stress test results are also interesting. They are posted in their IR website. The net result is that they would get through the Great Recession about breakeven. I think thid is better than most banks would do.

 

Obviously also running a bank to finance the CC receivables is key. I believe thwt during the Great Recession under GE Financial, they were living off commercial paper directly or indirectly.

[Simple Investor]

quick question. Is the spread between what they pay depositors and what they get in cc interest shrinking?  As rates rise they are paying more to depositors but i didn't think they could charge more interest on the cc's.  Credit card interest rates looked capped out. 

 

First level thinking on my end.  I have liked this investment for a couple of years but didn't pull the trigger. 

[tol1]

quick question. Is the spread between what they pay depositors and what they get in cc interest shrinking?  As rates rise they are paying more to depositors but i didn't think they could charge more interest on the cc's.  Credit card interest rates looked capped out. 

 

First level thinking on my end.  I have liked this investment for a couple of years but didn't pull the trigger.

 

It is all public. I would include peers in that consideration as well.

 

[NBL0303]

 

It is a cyclical business. 10% chargeoffs during last recession -outch! Even 5.8% right  ow when everything is peachy seems kind of high.

 

Exactly - I believe this is the primary reason for its market cheapness (relative to the current prevailing market valuations) - because investors see their chargeoffs began rising and many are thus pricing in the even higher chargeoff rate reached in the last recession.  It is obviously concerning when their chargeoff rate is rising - even though the economy is still growing/thriving etc.  It is easy to imagine ugliness ahead when the economy turns and 6% becomes something higher.

 

This is the standard reversion to the mean argument. You have to look at their BS to understand what has changed vs 2008 and you will understand why it is an attractive investment.

 

I actually agree with you - but I am very interested why it might be cheap and asking whether or not those with lower valuations (i.e. the market valuation) are "right." 

 

But there are many reasons that Synchrony is not nearly as vulnerable either to a recession or just in general as many analysts think.  For one, their credit quality profile has completely changed for the better and dramatically since the last recession. 

[HJ]

In the late 90's, when credit card had its dramatic growth period, the store card business was always viewed as a worse business than the general card business.  When a customer has multiple cards in his wallet, there is a hierarchy in his mind on which card to default first.  Store cards was always viewed as the first card consumer will default on.  The card they get from their bank, that's the last card they will default on.  Store cards performance also suffer whenever the store itself go bankrupt. So credit wise it's viewed as a significantly less resilient business during credit shocks.

 

The changes in the network piece of the business is actually very subtle, and could be meaningful.  Visa and Master were organized as cooperatives until this past decade, and interchange fees were significantly lower than it is today.  If you think of 2-3% ROA as a return that cad issuer want to earn, interchange fees itself these days are 2-3% (although the networks actually only get a very small fraction of that).  Synchrony does own its own network.  Just a significantly smaller network than Visa/Master.  Discover also owns its own network, as opposed to someone like Capital One / JPM, who while issue cards, issue them off of Visa and Master networks, not their own.  The fact that Visa and Master has been raising interchange fees dramatically after they became profit seeking entities has, in a way, made the smaller networks more valuable.  But this aspect of the business is being used more as a marketing tool for Synchrony to give data transparency to retailers rather than milking its earning power.  Interestingly, JPM has recently gone down the path wth Chase Paymentech to take back a greater degree of control over the network itself.  It clearly validates the view that owning your own data is going to be important going forward.  The question is, has the store card business changed enough, or will it change enough, so that this aspect of the business is more relevant than the pure credit aspect.  Argument can be made either way.

[NBL0303]

In the late 90's, when credit card had its dramatic growth period, the store card business was always viewed as a worse business than the general card business.  When a customer has multiple cards in his wallet, there is a hierarchy in his mind on which card to default first.  Store cards was always viewed as the first card consumer will default on.  The card they get from their bank, that's the last card they will default on.  Store cards performance also suffer whenever the store itself go bankrupt. So credit wise it's viewed as a significantly less resilient business during credit shocks.

 

The changes in the network piece of the business is actually very subtle, and could be meaningful.  Visa and Master were organized as cooperatives until this past decade, and interchange fees were significantly lower than it is today.  If you think of 2-3% ROA as a return that cad issuer want to earn, interchange fees itself these days are 2-3% (although the networks actually only get a very small fraction of that).  Synchrony does own its own network.  Just a significantly smaller network than Visa/Master.  Discover also owns its own network, as opposed to someone like Capital One / JPM, who while issue cards, issue them off of Visa and Master networks, not their own.  The fact that Visa and Master has been raising interchange fees dramatically after they became profit seeking entities has, in a way, made the smaller networks more valuable.  But this aspect of the business is being used more as a marketing tool for Synchrony to give data transparency to retailers rather than milking its earning power.  Interestingly, JPM has recently gone down the path wth Chase Paymentech to take back a greater degree of control over the network itself.  It clearly validates the view that owning your own data is going to be important going forward.  The question is, has the store card business changed enough, or will it change enough, so that this aspect of the business is more relevant than the pure credit aspect.  Argument can be made either way.

 

HJ - Really insightful and interesting post. 

[Spekulatius]

I agree that SYF running their own network is very relevant. The lack of interchange fees should make them very competitive against other bidders for store card contracts and keepibg the data in house and sharing them with customers helps as well.

[abitofvalue]

dont all the store card guys run their own networks.. this is a major selling point for a retailer.. no merchant discount/interchange..  ADS does run their own network too right? I assume the others do something similar.. The industry is very consolidated. basically SYF, ADS, Cap One, Citi and Wells make up a vast vast majority of the industry and building a network cant be hard (you only need acceptance at the retailer so no real sales needed).

 

It's attractive because its cheap relative to historic multiples.. Investors simply dont believe that SYF will deliver 5.5-5.8% NCOs as they have guided too. Management has very limited credibility on NCO guidance since they have had to revise it upwards a couple of times in their short history as a public company... belive stock was down 10%+ (on revision day itself) each of the past two times so no one ones to be in the stock when that inevitably happens this year (or so the thinking goes).  why blow a quarter when you can buy it post guidance revision..

 

PayPal acquisition will use a bunch of the extra capital but that also will result in taking on worse credit... PYPL portfolio is almost certainly weaker than SYFs.. so despite the big slowdown in growth and "stabilization" of credit theory, there is limited belief that credit will actually stablize at current levels.

 

All that said, i suspect it is too cheap at current levels. If they deliver on their guidance or even if the actual performance is a little worse.. the earnings growth can be quite attractive.   

[tol1]

SYF announced the 2nd buyback within 12 months, but the share has not reacted at all. Any idea what is going on? They have bought back 15% of the current MC within the last year.

 

[scorpioncapital]

Have there been studies published on the lag between stock buybacks and share appreciation?

I mean there are many variables. Options to buy stock could offset some of the buyback. Also, what about liquidity? And clearly for a large company, a bear market may supersede any large buyback bump. Suppose the stock was going to fall 15%, maybe the 15% buyback just made it stay even..

[tol1]

I don't want to make it too theoretical. SYF's overcapitalization is at least one of the key parts of my thesis. Seems to me investors simply apply 2008/09 NCO rates which does not make sense.