NAVI - Neutral On Navient Until Earnings Growth Improves

2023-09-19 07:00:00 ET

Summary

• Navient stock gets a hold rating today, in line with consensus from analysts and the quant system.
• Positives: dividend stability & 3.5% yield, company financial health, valuation lower than sector.
• Headwinds: share price appears high now, earnings YoY decline.
• Risks of federal student loan forbearance ending this month were discussed.

Research Summary

Today I'll be rating Navient ( NAVI ), in the financials sector, consumer finance subsector.

As this is my first time rating this stock, I will make some use of their most recent Q2 earnings results that came out on July 26th, in addition to data from Seeking Alpha and other sources.

For readers less familiar with this company, here are a few relevant points from their website that I think could be interesting to readers: best known as a student loan company, but also has other business segments such as business processing solutions, customer contact solutions, collection services, and payment processing solutions for the public sector.

Two key peers of this company, according to Seeking Alpha data, are Enova (ENVA) and Bread Financial (BFH).

Rating Methodology

Using a streamlined, structured process similar to 5 project phases in project management, I break down my overall holistic rating of this stock into 5 categories I rank individually and of equal weight: dividends, valuation, share price, earnings growth, company financial health.

If I recommend this stock on at least 3 of 5 categories, it gets a hold rating. 4 of 5 gets a buy, and less than 3 gets a sell rating. Then I compare my rating to the consensus from analysts, Wall Street, and the SA quant system.

Then, I explain any upside or downside risks to my outlook.

Dividends

In this category, I will analyze the dividends of this stock and whether I think they present an opportunity for dividend-income investors. The data comes from official Seeking Alpha dividend info.

As of the writing of this analysis, the forward dividend yield is 3.58% , with a payout of $0.16 per share on a quarterly basis, with a most recent ex-date of Aug. 31st. This yield appears competitive at first glance, but let's see how it compares to the sector average.

When comparing to its sector average, this dividend yield is 6.8% below its sector average.

I believe this is an only slightly negative point to consider for dividend investors who are comparing multiple stocks in which to invest. In my opinion, my target range for this stock's yield is 2.8% - 5.8%, to stay within a few points of the sector average. In this case, the yield seems almost in line with average.

In looking at the 5-year dividend growth for this stock, it has shown a flat growth trend. This is, in my opinion, a modestly negative point for dividend investors and a what I would say is a sign of this firm's restrained capacity to return capital back to shareholders, though maintaining stability.

Additionally, I am looking for stability with dividend payouts, and this stock has shown regular dividend payment history lately without interruption, even though it has kept the payout the same in this period shown in the table, remaining at $0.16 a share.

So, although the 5-year dividend growth is not anything impressive, it also is not negative and it shows stability, as does the steady dividend payouts. The yield is not far from the average, and I think it being over 3.5% makes it modestly competitive in my opinion.

I would therefore recommend this company on the category of dividends.

Valuation

In this category, I will analyze the valuation of this stock. The data comes from official valuation info on Seeking Alpha, specifically the forward P/E ratio and forward P/B ratio, the key metrics I look at.

This stock has a forward P/E ratio of 6.13 , which is 37% below its sector average.

I think that a reasonable price to earnings for this stock would be between 6x earnings and 11x earnings, to stay within a reasonable 2.5-point range of the average. In this case, on this metric the stock appears reasonably undervalued vs its overall sector.

This stock has a forward P/B ratio of 0.71 , which is 29% below its sector average.

I think that a reasonable price-to-book value for this stock would be between 0.50x book value and 1.5x book value, to stay within a 1/2 point range of the average. In this situation, this stock appears reasonably undervalued vs its overall sector.

Based on the examples I gave, I would recommend this stock on the basis of valuation.

Share Price

Next, I determine if the current share price is a potential buying opportunity based on my portfolio goal of buying at current price, holding for 1 year until Aug. 2024, and achieving an unrealized gain of +10%.

The price chart (as of the writing of this article) shows a share price of $17.88, compared to its 200-day simple moving average "SMA" of $17.23 , over the last 1-year period. I like using the 200-day SMA as it is a long-term trend indicator that smooths out the trend nicely.

Next, I plug in the current SMA and share price into the following simulator I created, which simulates unrealized gains & losses if the share price as of Aug. 2024 reaches +10% above the current SMA but also if it drops -10% below the current SMA:

In the above simulation, my goal is to meet or exceed a +10% unrealized gain in 1 year, and I have a maximum loss tolerance of -10% unrealized loss.

Based on the simulation results testing the current buy price, I fall short of my goal for realized gains by 4%, and I also exceed my loss tolerance by 3.27%.

In this case, I would not recommend the current buying price, considering it already in the "moderately overpriced" range.

To better illustrate my desired "trading range" in relation to the SMA, I created this chart with blue arrows showing the +/- 10% vs the SMA. The current share price appears to be in the upper area of this range.

Since every investor has different profit goals and risk profiles, consider this simulator just a general framework to help think about this stock in a longer-term sense.

Earnings Growth

In this category, I examine the earnings trends over the last year, looking at both top-line and bottom-line results but also any relevant company commentary from the last earnings results.

At first glance, I can see that this firm picked up a lot of tailwind in the last year from interest income, however also picked up interest expense too, leading to a YoY decline in "NII", or net interest income , which is a key metric I follow in this industry. This is one modestly negative point for this firm.

Since it appears the current rate environment will remain for some time, as predicted by the latest sentiment from rate traders as tracked by CME Fedwatch , I expect the above situation could continue going forward in the next quarter.

Another negative point to call out is the total revenue also saw a YoY decline, which I am disappointed by.

In addition, the net income also saw a YoY decline, casting a shadow on the bottom line for this firm.

To help me understand what caused some of these headwinds, I turned to the Q2 earnings comments .

According to the company:

Net interest income decreased $40 million primarily due to the paydown of the loan portfolio as well as a reduction of Floor Income earned.

Other revenue decreased $8 million primarily due to lower contract-exit transition services and the paydown of the loan portfolio.

In looking at the firm's situation from another angle, consider the following table which shows the headwinds in one of their core business segments: federal education loans. In the last quarter reported, they saw declines in both revenue and net income while seeing an increase in provisions for loan losses.

The explanation the company gave for the increase in provisions was " related primarily to an extension in the estimated remaining life of the portfolio and the resulting increase in expected future defaults."

Based on this evidence as whole, I would not recommend in this category and expect continued challenges in the next quarter.

Financial Health

In this category, I will discuss whether the overall company shows strong financial fundamentals beyond just things like dividends, valuation, earnings and share price, with a focus on the capital strength.

One thing I want to call out, from their Q2 presentation, is:

We distributed $100 million, or 152% of net income, to shareholders through dividends and share repurchases.

Again, this is a sign of committing a return of capital back to shareholders, which always earns a point in my book.

In understanding their strategic vision, the following triangle really helps show the direction they are aiming for, one that certainly gives me confidence as an analyst:

Another factor I look at, as you see in some of my prior articles here, is whether a company generates "positive equity", meaning assets exceed liabilities. It sounds like a basic business concept but I think it is a sign of financial health.

Navient has shown positive equity for quite some time, as per their balance sheet . In fact in Q2 it had positive equity of $2.9B, similar to prior quarters.

Also, I would call out the fact that this firm is cash rich, with $1.3B of it, in addition to the billions in loan assets it holds on the books.

It's total liabilities in Q2 were $62.6B.

Based on the data, I recommend in this category, and consider it a firm with solid fundamentals.

Rating Score

Today, this stock was recommended in 3 of my 5 rating categories, earning a neutral /hold rating from me today.

This is actually in line with the consensus from analysts, Wall Street, as well as the quant system which I am agreeing with this time!

My Rating vs Downside & Upside Risk

My rating can face the following potential downside risks that could make my neutral rating overly positive-sounding:

One of those risks is that the current forbearance period on federal student loans in the US (which launched in 2020) is coming to an end this September & October 2023.

According to a recent article in CNET ,

After a pause of more than three years, interest on federal student loans resumes Friday and, in October, more than 43 million Americans will need to start making payments again. Many borrowers will face "payment shock" as they have to budget for this substantial new expense. Nearly half say they aren't ready to start paying down their education debt again.

At first glance, many investors & analysts may see this as a risk for lenders & loan servicers like Navient, assuming there will be a wave of loan defaults coming soon.

However, according to an article in Forbes , you may or may not know that there is also an "on-ramp" period from Oct. through Sept 2024 in which time unpaid loans will not be considered "delinquent" yet. So, I think that this is great news for Navient actually.

The other risk I want to highlight is that there has been some litigation against Navient, and well-publicized cases like that in the media could spark bearishness from investors.

For instance, according to a Sept 12th article in Business Insider, Navient was accused by the Labor Department of hiring discrimination. However, the good news is that it appears to have reached a $700K settlement although did not admit to wrongdoing, similar to a "settlement" it reached in 2022 with 39 states who accused Navient of "widespread unfair, deceptive, and abusive student loan servicing practices and abuses in originating predatory student loans," according to the same article.

My rating can also face an upside risk as follows:

Besides loans, as already mentioned one of this firm's segments is "business processing" solutions, and this could prove to be a growth area for it which could cause further bullishness and make my rating too cautious.

Consider that, according to their Q2 presentation, "revenue from ongoing government and healthcare services grew by 38% or $23 million" even though overall net income in this segment had a YoY decline.

Given the above points of evidence, my "hold" rating stands because I have shown why I think the actual downside risk is very minimal and for now I think the upside risk is perhaps further out, as I think the firm has a ways to go to improve their numbers in the business process segment.

Analysis Wrapup

To wrap up today's discussion, here are the key points we went over:

This stock got a hold rating today.

Its positive points are: valuation, dividends, financial health of company.

The headwinds it faces are: share price, earnings growth YoY.

Both upside & downside risks have been addressed.

In closing, I admit this analysis was a bit more reading material than some research articles, but the world of student loans can be a complex one, and it is important to touch upon multiple angles of this stock.

I encourage feedback in the comments section to focus on this firm not from the perspective of a borrower or the student loan "debate" which is another topic altogether, but that of an investor or analyst and seeing this firm through the lens of financial fundamentals.

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