2023-06-09 07:19:28 ET
Summary
- Ally Financial is a mature combined insurance/banking business with weakening near-term performance and no clear upward trajectory, despite a recent blip of improving per-share metrics.
- The company has an inferior net margin and forward EPS growth rate compared to the financial sector overall, with declining earnings expected in the coming years.
- Ally Financial's dividend yield of 4.21% is relatively secure but simply not compelling in the current market context.
- As such, I don't see the cheap valuation as an opportunity and would rate this stock a hold.
Overview
Ally Financial (ALLY) is a tenured bank and diversified financial services entity. First founded back in 1919 as an auto insurance provider for General Motors, it spent most of its operating history as the General Motors Acceptance Corporation. The company went through a restructuring in the wake of the 2008 financial crisis and was subsequently renamed Ally Financial, subsequently continuing on to an initial public offering in Q2 2014.
Since going public, Ally has significantly trailed the S&P500 in terms of price return, also closely correlating with the index throughout most of this time.
Suffice to say, this hasn't been that great of a stock to own. Its price trajectory has resulted in its shares trading at a discounted valuation relative to its financial services peers, with a significant discount across both GAAP and non-GAAP metrics. Ally Financial's forward valuation comes in at a relatively smaller discount than its trailing valuation, indicating a marginal degree of forward optimism priced in to the stock.
Bargain been stocks such as this one tend to have good reasons for trading cheaply, particularly so in the financial services sector. In this article I'll evaluate where Ally Financial stands from a fundamental perspective and whether it might be worth picking up shares at these prices.
Business
Before diving into Ally's financials, it is worth clarifying the exact nature of its business. Ally primarily provides auto financing, digital banking services, and mortgage loans for these customers. It is also a licensed brokerage with which customers can buy and sell securities. We can neatly visualize its operational footprint with a slide from its most recent quarterly results:
This indicates that Ally is very much a standard consumer bank that also happens to provide insurance. While not a wholly unique combination, it is nonetheless not overly common for both of these activities to occur under one roof. While there may very well be economies of scale to this, this article will not focus on that aspect of Ally's business and instead establish a fundamental profile for the firm using amalgamated metrics.
Fundamentals
Since we have an entire decade's worth of financials for this company, we can apply a broader lens to its financial statements. Starting with revenue, we see that the firm has grown over the last decade. This growth has unfortunately come punctuated with volatility, with 4 years out of the last 10 showing a decline in the top line. Record revenues of $8.7B in 2021 were followed by a decline to $7.9B in 2022.
This was accompanied by significant increases in the company's cost profile. In 2022, Ally experienced a record increase in its core operating expenses of 19.7%, driven by materially higher employee salaries and rent.
This combination of declining revenues and increased costs has unfortunately seen the company lose more than 40% of its net income from 2021 to 2022, with the trend continuing in its most recent quarter.
These financials speak of a business with no clear upward trajectory as well as worsening unit economics.
When we look at per-share financial metrics, however, the picture becomes a lot more interesting. Ally has been able to repurchase a material share of its float over the past two years and translate this into much higher earnings per share. Its 2022 EPS of $5.04 may not have matched that of 2021 but is still well above what the company has posted throughout the last decade.
Looking at this more granularly, we can see that the firm has not maintained EPS growth momentum quarter over quarter. The end of 2022 and the first quarter of 2023 shows a decline in diluted EPS and what is likely to be another down year for the firm.
Overall it looks that Ally Financial is a mature business with weakening near-term performance. While able to maintain higher-than-expected EPS for 2022, Ally is not carrying this trend forward into this year. It is worth looking at its relative financial metrics to see if the firm has some kind of leverage for moving this upwards.
Relative Financials and Valuation
Looking at Ally's relative financials, we can see that the picture is not ideal. Ally has an inferior net margin and forward EPS growth rate as compared to the financial sector overall. Indeed, it is expected to see declining earnings even while the sector is projected to eke out some growth in the 1-5 years ahead.
The bright spot here is Ally Financial's dividend profile. The company has been growing dividends for 6 years and is now offering a forward yield of 4.21%. I would consider this a relatively secure yield given its business.
The caveat is that this dividend yield doesn't go for much in the current market context. With T-bills paying 5.25% there is no incentive to take on Ally's 4.21% yield.
Notably, Ally Financial has more cash on hand than its market cap. This is as good a margin of safety as you can get, but there is also no reason to think the firm will be liquidated any time soon. As such, it is simply an indicator that it will continue to be a going concern. Furthermore, it is limited in its capacity to use this cash due to the liquidity needs inherent in the insurance business.
The core risk that I see here is continued divestment that would yield a lower day-to-day trading multiple than what we already have. Since the firm has negative growth prospects, an increasing cost structure, and a dividend yield that is below what T-bills offer, it does not present a compelling picture to investors. This could very well result in further selling off in the shares and a lower day-to-day trading multiple, even with everything else being the same.
Conclusion
Ally Financial appears to be a cookie-cutter company without anything to make it interesting in the near-term. My outlook here is that this stock will roughly maintain its price while continuing to relatively underperform the S&P. At this yield, I see no reason to establish a position. I would also caution investors against doing so because of the risk of further share price depreciation. While not a sell, this one's definitely not a buy. I will rate it a hold.
For further details see:
Ally Financial: Trading Cheaply, But Not Worth Buying