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Morningstar | Lowering Synchrony's FVE by 23% to $32 per Share After Loss of Walmart. See Updated Analyst Note from 31 Jul 2018

After updating our forecast model, we are lowering narrow-moat Synchrony Financial’s fair value estimate to $32 per share. In addition, we are lowering our stewardship rating to Standard from Exemplary and raising our uncertainty rating to high. We now have doubts that management has adequately prepared the company to compete against larger players with better technology and data platforms, such as Capital One. We doubt that Walmart’s decision to leave Synchrony came down solely to price; rather, we think it also stemmed from Capital One’s better technology and data platform. Currently, we’re forecasting average loan receivables to decline 5% and 6.4% in 2019 and 2020, respectively. Effectively, we see Synchrony going from generating returns on equity in the upper teens to low 20s to generating returns in the midteens. We forecast earnings per share of $3.69 for full-year 2018 and project little to no growth over the next four years. This is about a 20%-25% decline from what we had previously been expecting. Though Synchrony will benefit from one-time reserve releases, which will make EPS noisy, we estimate that net interest income will decline by 8% in 2020.

Overall, losing Walmart raises a lot of questions for Synchrony. Management commented that it intends to compete to retain Sam’s Club’s portfolio, which we estimate represents 7%-9% of Synchrony’s total receivables, but also stated that retaining Walmart would not have been earnings-accretive compared with losing the portfolio. We suspect losing the Walmart business came down to Synchrony’s inability, not necessarily willingness, to match Capital One's offer. We struggle to find a reason that anything would change when the Sam’s Club deal expires that would enable Synchrony to retain the business. For now, we think investors should expect Sam’s Club to go to Capital One. In addition, we worry Walmart’s departure will motivate Synchrony’s other partners to entertain other offers, and at the very least, to demand more from Synchrony in terms of revenue split and marketing dollars.

Our most positive takeaway is that in our view, this supports our thesis that Best Idea Capital One is the better company with a longer-term focus. Winning Walmart may come at a short-term cost to Capital One’s margins, but we think winning this business will generate a long-term benefit that will eventually be accretive to shareholders. Currently, Capital One trades at a 35% discount to our fair value estimate. Capital One may have to limit future increases in dividends and share repurchases to appease regulators, but overall, investors are better off having Walmart’s portfolio.