Morningstar | One Quarter After Announcing the Loss of Walmart, Synchrony Produces Impressive Results
No-moat Synchrony’s third quarter was a bright spot after a series of lowlights for the company. If it weren’t for the pending loss of the Walmart credit card portfolio, we’d be pleased with the company’s performance. The firm earned $0.91 per share, an increase of 30% from the prior-year third quarter. Much of this growth is attributable to receivables growth and lower credit losses. For the quarter, average receivables grew by 16.5% from the previous year. We’ll remind investors that this quarter, Synchrony welcomed PayPal’s credit portfolio to its balance sheet. If Synchrony is to regain momentum after the loss of Walmart, its relationship with PayPal will have to play a key role. In addition, Synchrony benefited from improving credit quality, supporting our thesis that the company’s rising provisions were a result of growth. Credit provisions as a percentage of average receivables were 6.7%, a nearly 20-basis-point decline from the previous year. In addition, net charge-offs were just under 5%, in line with the previous year. Synchrony has either turned the corner on credit quality or is very close. Today’s results were comparable to our short-term expectations, and we’ll be maintaining our fair value estimate of $28.50.During the quarter, the company re-signed Lowe’s and JCPenney, which should calm fears of additional defections. Management said investors should expect a similar earnings profile from these partnerships going forward, but also remarked that they "enhanced some of the growth commitments and value propositions." While we’re happy to see that there doesn't appear to have been a significant change in retail share, we suspect that management's comments suggest that loyalty rewards may increase for these partnerships. We’ll be paying close attention to Lowe’s card benefits to see if changes are made to its already handsome discounts and what impact they may have on the bottom line. For now, loyalty spending appears stable.
Management gave no indication as to what its plans would be for the existing Walmart portfolio. The company can keep the receivables and convert the balances to a new Synchrony-branded Mastercard, or the receivables can be sold to Capital One. In addition, management reiterated its belief that Walmart’s departure is an outlier and the company will be able to renew deals. If Synchrony retains the portfolio, we have to think that this would reduce the amount of capital returned to shareholders and potentially weigh on the company's overall returns. However, it would lessen the initial impact to earnings. For now, our model assumes that Synchrony will sell the Walmart portfolio to Capital One.
During the quarter, Synchrony wasted no time in putting capital to work by repurchasing a substantial number of shares. Diluted shares outstanding fell by 2.6%, the largest single quarterly decline since the company went public. This provided a boost to EPS of about $0.03. At the end of the quarter, Synchrony’s total assets stood at 7.5 times equity, compared with being leveraged 6.4 times equity a year ago. We believe that leverage will increase only modestly as the company continues to buy shares before the departure of Walmart.
Though management discussed the firm's data and analytics and improving its technological capabilities, few details were provided. In addition, it’s not apparent from looking at the company’s income statement that Synchrony has increased technology spending to make these improvements. We still believe that Synchrony is a laggard in technology and is only beginning to address these issues. We believe Synchrony should significantly increase its spending on technology even if it comes at the expense of margins. We highlight our concerns in our recent Select presentation titled "Capital One: A Moat in Tech That Vikings Can’t Surmount," which we encourage clients to read.
Synchrony Financial is a savings and loan holding company and financial holding company. Through its subsidiaries, the company delivers a range of financing programs, as well as consumer banking products, across key industries including digital, retail, home, auto, travel, health and pet. The company provides a range of credit products through its financing programs which it has established with a group of national and regional retailers, local merchants, manufacturers, buying groups, industry associations and healthcare service providers, which it refers to as its partners. Through its partners, the company provides their customers a variety of credit products to finance the purchase of goods and services.
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Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.
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