EUR 850.00 For Business Accounts Only

Morningstar | Placing Synchrony Under Review; We Expect to Decrease Our FVE Approximately 20%

After listening to narrow-moat Synchrony Financial's earnings call, we are placing our fair value estimate for the firm under review. We expect to have an updated report for the company July 30 and that our fair value estimate for the company will decrease approximately 20%. We are also reviewing our stewardship rating for the firm.

We expect to continually update our forecast as new information is made available. Specifically, we have questions about how Synchrony's other partners will react to Walmart's departure. Also, despite management’s comments that they intend to compete to retain Sam’s Club, we have to conclude Capital One now finds itself on the inside track to win this business. It would appear Synchrony is going to be challenged for growth. We believe Synchrony’s partnership with PayPal looks promising, but it will take time to offset the EPS impact of the current business losses. During the call, management said they believe they can replace the lost EPS, but gave no timeline as to when that would happen. The company still expects to grow receivables by 13%-15% this year, but after that we expect average receivables to decline by 4%-6.5% in each of the two following years.

When judging the impact on EPS, the next few years will be noisy. Synchrony can choose to sell its Walmart portfolio to Capital One or retain the card balances and convert the cards to general purpose credit cards. For now, our forecast assumes the portfolio is sold. The company said it expects to generate a gain on sale, but we aren't sure why the valuation would be materially higher than the book value of these assets. Given that this frees up capital, we expect Synchrony to repurchase around $2.5 billion in shares. Previously, we expected Synchrony to earn $4.58 per share in 2021 and $5.13 in 2022. We now believe Synchrony will earn somewhere in a range of $3.30-$3.70 per share each year in the final two years of our forecast, comparable with this year's earnings.

In our mind, this raises a lot of questions as to what will happen to Synchrony’s other large partnerships. J.C. Penney is a large partner, but may not be economically viable in a few years. In addition, other large partners like Gap and Lowes may follow Walmart’s lead and be tempted to entertain competing offers. Increasingly, we feel it will be challenging for Synchrony to grow and the growth it does generate may come at a greater cost than it has historically.

Overall, we viewed the earnings call as putting an overly positive spin on the situation. Furthermore, due to this significant business loss, we’ll be re-examining our stewardship rating for Synchrony, which is currently at Exemplary. Unless, Capital One has overpaid and overpromised to win Walmart, which we doubt, Synchrony either has a less efficient cost structure or lacks the capabilities in data its rival has. Combining published reports with Capital One’s commentary, we would suspect this deal didn’t come solely down to price and the reason Synchrony couldn’t retain Walmart might be because it required Synchrony to make a significant investment in technology; an investment Capital One has already made. That said, we will continue digging until we get greater clarity as to why Synchrony lost this business.