SLM - SLM Corporation: Don't Let The Q3 Results Fool You

2023-11-10 10:26:33 ET

Summary

• SLM Corporation is a student loan provider with a focus on private student loans in the US.
• Q3 FY2023 results showed a decline in net income, but strong interest income growth and a delayed loan sale are expected to positively impact future results.
• SLM is trading at a significantly cheaper valuation compared to the sector, making it an attractive investment opportunity.

Investment Thesis

SLM Corporation ( SLM ) is an American student loan provider with its headquarters in Newark, United States. In this thesis, I will be analyzing the company’s third-quarter results and its future growth prospects. I will also be discussing its valuation at current price levels. Considering the consistent student loan portfolio and strong interest income growth, I assign a buy rating for SLM.

Company Overview

SLM was originally a government-sponsored enterprise ((GSE)) created to support federal education loan programs. In recent years, it transitioned into a private company, operating primarily in the private student loan sector. It offers financial products and services to help students and families navigate higher education costs under the brand name Sallie Mae. These services include private education loans, banking products, and college savings plans to assist individuals in managing their educational expenses. The company mainly focuses on student loans for undergraduate and graduate courses in the United States.

Q3 FY2023 Result

SLM reported a mixed quarterly results, with revenue beating the market estimate by 5.2% but the EPS missing the estimate by a significant 66%, falling almost 62% on a y-o-y basis. However, before jumping to any conclusion, it is crucial to understand the reason behind this fall in net income. In Q3 2022, the company closed a sale of $1 billion worth of loan portfolio to a third party, gaining $75 million in profits. It planned on selling a $ 1 billion loan portfolio in Q3 FY23, but the sale got delayed to Q4 FY23 but the company managed to close the deal in October, gaining $70 million in the process. The positive impact of this sale will be visible in the Q4 results. I believe this fall in net income is not a major cause of concern and is temporary in nature. The company is on the right track, improving its loan portfolio mix and organic interest income growth.

SLM reported interest income from loans of $581 million, up a solid 20% compared to $483 million in the corresponding quarter last year. As per my analysis, the primary reason behind this increase was a better charge-off ratio, in simpler words, a non-performing loan ratio of 2.53% compared to 2.7% in Q2 2022. Along with this, a better interest rate mix helped the company achieve this growth. The net interest income margin improved from 5.27% to 5.43% on a y-o-y basis. I believe the company is employing a strategic loan portfolio mix, which will enable it to achieve better margins in the coming quarters. The net income stood at $29.4 million, a steep decline of 61% compared to $75.1 million in the same quarter last year. The reason, as I mentioned earlier, was the delayed loan sale, which closed in October this year. The diluted EPS stood at $0.11, down $0.18 compared to $0.29 in Q3 2022. The company’s management thinks this deal could have added $0.31 to the Q3 results, but this gain will now be visible in the Q4 results.

Overall, the company posted weak results in terms of net income. However, the interest income growth remained solid and consistent. The FY23 guidance by the management remains unchanged, with diluted EPS estimated to be in the range of $2.55-$2.65 despite the EPS decline in Q3. I believe the company should be able to achieve this target given the $70 million gain that it realized in October and consistent growth in interest income.

Key Risk Factor

Concentration Risk

The maximum number of assets in the form of loans and other services are concentrated in the private education industry. Not just the industry concentration but the geographical concentration is a risk that investors should consider before investing in the company. The complete business of SLM comes from loans for education in US colleges. The company employs hedging strategies through derivatives to manage interest rate fluctuation risk, which is a positive sign, but being concentrated in one particular industry is still a risk for SLM.

Valuation

SLM is currently trading at a share price of $14.85, a YTD decline of 10%. It has a market cap of $3.4 billion. SLM is trading at a forward P/E multiple of 5.7x, considering the midpoint FY23 EPS estimate of $2.60 provided by the management, which I believe they will achieve given their recent net interest income performance. The company is trading at a significantly cheaper valuation than the sector forward P/E of 8.9x. SLM is one of the major players in student loan financing, and I believe they should trade at a higher valuation.

Conclusion

The decline in net income should not be considered a severe problem with the company but a temporary hiccup. The company is well positioned in the market, employing a strategic loan portfolio mix and interest income growth. The company faces the risk of being in a concentrated geography and industry, but the cheap valuation provides a favorable risk-reward opportunity. Considering all the growth and risk factors, I assign a buy rating for SLM.

For further details see: