Description

Investment Thesis

We believe that shares of Synchrony Financial (NYSE: SYF) represent a cheap way to play an economic rebound from COVID-19. The stock has been written up a couple of times on VIC (most recently in 2017 by Ozyman2) for more background information.  This stock has persistently traded at a high-single/low double digit multiple (along with most other credit card companies) due to fears that they were under-reserving for an eventual economic pullback.  The company will clearly earn a great deal less in 2020 due to lower receivables and higher reserve builds/NCOs.  However, we think there is a chance for a substantial re-rating of the stock as it survives the current economic crisis.  We think you today you are paying less than 8x 2021 EPS for a high-quality company with a strong balance sheet and very shareholder-friendly management team.   

The company clearly faces many headwinds this year including lower retail sales, several partners closing stores (including some large partner bankruptcies – JCPenney being one of their largest partners), higher NCO’s, etc.  However, implicit in our thesis is that government intervention, in terms of stimulus payments and increased unemployment benefits, will continue to be a bridge into a stronger recovery next year.  If you tend to take the other side of this argument, this stock may not be for you. 

Company Overview:

Synchrony Financial is a provider of private label credit cards and was spun out of GE in 2014. As of December 31, 2019, the company’s five largest partners were Gap, JCPenney, Lowe’s, PayPal, and Sam’s Club.  A breakdown of retail partners can be seen below:

Synchrony Financial issues the credit card under the retail partners name.  The partner is then responsible for card promotion, but Synchrony has final say in credit issuance and owns the underlying receivables generated in the program.  Most of these deals include “Retailer Share Agreements,” which provide for payments for partners when the program’s net performance exceeds an agreed upon net return.  Over the past few years, these payments have averaged ~4-4.5% of receivables.  

Synchrony net interest margins have averaged ~16% in the past few years (this number is pre-RSA) so Synchrony has been sharing about a quarter of the portfolio return with its partners.  However, the real benefit will come to SYF in times like the current economic downturn.  When portfolio returns decrease (whether due to higher reserves/NCO’s, lower receivables, etc.) SYF’s payments to its partners also decreases so that the company’s hit is not 1:1 on pre-tax income. 

The buffer from RSA’s as well as a much better credit portfolio compared to the 2008/2009 crisis should lead to better outcomes than feared (net charge-offs for the company hit low double digits at that time – we are modeling high single digits for a couple of quarters surrounding the new year).   

Management has been very shareholder friendly and has lowered the share count by over 25% in the past four years. 

Valuation

Synchrony started to build reserves in the first quarter of 2020, and this will continue in Q2.  Net charge-offs have not appreciably increased (thanks to Uncle Sam) but are expected to by the end of the year.  We think the company will be fully reserved for this when they report 2Q numbers in a week or so and has plenty of room due to high CET1 ratio of 14.3%.  Due to this reserve build and lower receivables, the company may only earn ~$1.50 in 2020 if they are lucky.  However, we see a rebound into next year and think they could earn over $3 on a conservative basis with out aggressive assumptions (i.e. not assuming everything back to pre-COVID levels).  At the current stock price of ~$23 we see the company trading at less than 8x 2021 EPS.  This is pretty much in the range of multiples where the stock has traded in the past few years.  However, we think there is large upside to continued growth in EPS and, more importantly, a long-awaited re-rating of the stock.

SYF’s multiple has remained at low levels due to the constant fear of an eventual economic downturn and its effects on the company’s portfolio.  We think that if the company can move past this downturn and continue to grow, investors will finally award the stock a higher multiple.  We think a move in the multiple to 12-14x (still at a large discount to the market) is fair and do not think it would be crazy to see the stock trade well into the $40’s over the next year or two.  

Major Risks

• Economic downturn worsens or does not resolve itself in a timely manner

• Continued store closures from partners including those in BK (i.e. JCPenney)

Catalyst

- Inflection in EPS by the end of 2020