As of June 30, Berkshire Hathaway (BRK.B, Financial) owned $521 million worth of Synchrony Financial (SYF, Financial).
In its first half of operations, Synchrony Financial reported 12.1% revenue year-over-year growth to $7.88 billion and a contrasting (-)7.1% drop in profits to $995 million resulting in 12.6% margin compared with 15.2% a year earlier.
Total interest expenses (such as interest on deposits) climbed 7.3% while total other expenses (such as employee costs) rose 11%. Further, Synchrony recorded a 36.8% increase year over year in its provisions for loan losses to $2.63 billion thus dampening its profits in the recent period.
In the first half, Synchrony’s loan portfolio on credit cards, in which Synchrony has the greatest exposure to provisions, had 72% of its clients in FICO scores of 661 or higher compared with 73% in the year prior.
“Strong execution of our strategies yielded solid performance across our three sales platforms. Organic growth remains an important business driver and contributed meaningfully to this quarter’s results. Our focus on the application and development of digital innovations is yielding results as we continue to drive strong online sales volume growth and penetration. A primary funding objective for us is growing deposits, and we continued to execute on this, achieving double-digit growth again this quarter.
“We were pleased to announce a meaningful increase in our capital return to shareholders through dividends and share repurchases – this is a key priority, along with continued growth of the business while maintaining solid returns and a strong balance sheet.” – Margaret Keane, President and CEO of Synchrony Financial
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Valuations
Synchrony Financial is undervalued compared to peers. According to GuruFocus data, the company had a trailing price-earnings (P/E) ratio of 11.2 times vs. the industry median of 15.6 times, a price-book (P/B) ratio of 1.64 times vs. 1.3 times and a price-sales (P/S) ratio of 2.07 times vs. 3.73 times.
The company also had a trailing dividend yield of 1.85% with 20% payout ratio.
Average 2017 revenue and earnings-per-share estimates indicated forward multiples of 1.6 times and 11.95 times.
Total returns
Synchrony Financial has underperformed the broader Standard & Poor's 500 index so far this year having generated (-)18.36% total losses compared to the index’s 10.4% gains.
Synchrony Financial
According to filings, Synchrony Financial was previously an indirectly wholly owned subsidiary of General Electric (GE, Financial) Capital Corp. until the closing of the initial public offering of the former’s common stock in 2014, which reduced GECC’s ownership in the company to approximately 84.6% of Synchrony’s common stock.
In November 2015, GE performed a $21 billion share swap that led Synchrony Financial to become a stand-alone savings and loan holding company.
Synchrony is one of the premiere consumer financial services companies in the U.S.
The company’s roots in consumer finance trace back to 1932 – ~85 years ago –Â and it is the largest provider of private label credit cards in the U.S. based on purchase volume and receivables today.
Synchrony provides a range of credit products through programs it has established with a diverse group of national and regional retailers, local merchants, manufacturers, buying groups, industry associations and health care service providers.
During 2016, Synchrony financed $125.5 billion of purchase volume; in December of the same year, the company had $76.3 billion of loan receivables and 71.9 million active accounts.
Synchrony’s business benefits from longstanding and collaborative relationships with its partners, including some of the nation’s leading retailers and manufacturers with well-known consumer brands, such as Lowe’s (LOW, Financial), Walmart (WMT, Financial), Amazon (AMZN, Financial) and Ashley Furniture HomeStore.
The company’s partners promote its credit products because these products generate increased sales and strengthen customer loyalty. Meanwhile, Synchrony’s customers benefit from instant access to credit, discounts and promotional offers.
Synchrony has omnichannel (in-store, online and mobile) technology and marketing capabilities. For example, the purchase volume from its online and mobile channels increased by 26% for the year ended December 2016
Synchrony’s revenue activities are managed through three sales platforms: Retail Card, Payment Solutions and CareCredit.
Platforms
Retail Card
Retail Card is a leading provider of private label credit cards and also provides Dual Cards, general purpose co-branded credit cards and small and medium-sized business credit products.
In the first half, Retail Card has an average active accounts of 54.7 million –Â 3.7% higher than a year earlier. This platform also increased its loan receivables by 10% year over year while interest and fees on these loans grew 11% to $5.79 billion.
According to recent company filings, these increases in interest and fees on loans were primarily the result of growth in average loan receivables.
Payment Solutions
Payment Solutions is a leading provider of promotional financing for major consumer purchases, offering primarily private label credit cards and installment loans.
Payment Solutions’ active accounts saw the largest increase in active accounts by 11% to 9.06 million. Loan receivables for the platform increased by almost the same rate at 11.4% while interest and fees climbed 13.4% to $1.05 billion.
Further, the enhancement in overall interest and fees was also secondary to growth in loan receivables.
CareCredit
CareCredit is a leading provider of promotional financing to consumers for health and personal care procedures, products or services, such as dental, veterinary, cosmetic, vision and audiology.
Active accounts rose 9.2% year over year in the first half to 5.52 million, loan receivables climbed 11.2% year over year, and interest and fees on loans increased by 11.4% to $968 million. Similar to Retail Card and Payment Solutions, CareCredit achieved higher interest and fees secondary to loan receivable growth.
In addition, Synchrony offers its credit products primarily through its wholly owned subsidiary, the bank. Through the bank, the company offers, directly to retail and commercial customers, a range of deposit products insured by the Federal Deposit Insurance Corp., including certificates of deposit, individual retirement accounts, money market accounts and savings accounts.
Synchrony also takes deposits at the bank through third-party securities brokerage firms that offer its FDIC-insured deposit products to their customers.
As of June, Synchrony had $52.9 billion in deposits, or 13.9% higher than a year ago.
Meanwhile, Synchrony’s loan receivables portfolio has 10% exposure each in Texas and California, 8% in Florida, 5.6% in New York and 4.3% in Pennsylvania.
The company conducts its operations through a single business segment.
Company metrics
Net interest margin
Net interest margin is a ratio that measures how successful a firm is at investing its funds in comparison to the expenses on the same investments.
In the first half, Synchrony’s net interest margin climbed 30 basis points to 16.19%.
In fiscal years 2014, 2015 and 2016, net interest margin figures were 17.2%, 15.85% and 16.1%.
Return on assets (ROA)
In the first half, ROA declined 40 basis points year over year to 2.2%
In fiscal years 2014, 2015 and 2016, ROA figures were 3.2%, 2.9% and 2.7%.
Return on equity (ROE)
In the first half, ROE declined 230 basis points to 14%.
In fiscal years 2014, 2015 and 2016, ROE figures were 26.7%, 19% and 16%.
Efficiency ratio
It is believed that an efficiency ratio of 50% is the maximum optimal efficiency ratio. If the efficiency ratio increases, it means a bank's expenses are increasing or its revenues are decreasing.
In the first half, efficiency ratio declined by 90 basis points to 30.2%.
In fiscal years 2014, 2015 and 2016, figures were 31.7%, 33.5% and 31.1%.
Delinquencies
Over 30-day loan delinquencies as a percentage of period-end loan receivables increased by 46 basis points to 4.25% in June compared to a year earlier.
Net charge-offs
Net charge-offs consist of the unpaid principal balance of loans held for investment that we determine are uncollectible, net of recovered amounts.
In the first half, net charge-offs as a percentage of total average loan receivables were 5.42% compared to 4.51% last year.
Tier 1 leverage
The higher the Tier 1 leverage ratio is, the higher the likelihood is of the bank withstanding negative shocks to its balance sheet. Basel III established a 3% minimum requirement for the Tier 1 leverage ratio.
In June, Synchrony had a Tier 1 leverage ratio of 14.8% compared to 15% in December.
Common equity Tier 1 capital
Common Equity Tier 1 (CET1) is a capital measure that was introduced in 2014 as a precautionary measure to protect the economy from a financial crisis. It is expected that all banks should meet the minimum required CET1 ratio of 4.50% by 2019.
In June, Synchrony had a ratio of 17.2% compared to 17% in December of last year.
Sales and profits
In the past three years, Synchrony had revenue decline average of (-)0.3%, profit growth average 4.39% and profit margin average 20.4%.
Cash, debt and book value
As of June, Synchrony had $12 billion in cash and equivalents and $20.71 billion in total borrowings with a debt-equity ratio of 1.44 times compared with 1.41 times a year earlier. Overall debt climbed $1.4 billion year over year while equity increased by $617 million.
Of Synchrony’s $91.1 billion assets 1.95%Â were goodwill and intangibles while overall book value increased by 4.5% year over year to $14.3 billion.
Cash flow
In the first half, Synchrony registered 18.4% higher cash flow from its operations to $3.52 billion compared to a year earlier mostly brought by its higher loan losses provision.
Further, the company does not have capital expenditures but rather allocates much of its cash flow in investment securities at $1.1 billion (net purchases) and loan receivables acquisitions at $1.25 billion (net any increase). As a result, Synchrony allocated more cash to its loan receivables in the period.
In addition, the company took in $549 million in borrowings (net repayments) while having provided $886 million in payouts such as dividends and repurchases –Â 25% of its cash flow from operations.
In estimation, Synchrony repurchased 22.3 million of its shares in the first half at an average price of $30.31 each.
The cash flow summary
In the past three fiscal years, Synchrony Financial has reduced its debt by $5.02 billion (net any issuances), raised $2.84 billion in share issuances, generated $18.35 billion in free cash flow and provided $690 million in shareholder payouts.
Conclusion
Synchrony’s recent half operations indicated strong business growth albeit less profitable secondary to increase in loan provisions. Analysts alike expect the company to deliver strong revenue growth this fiscal year and a little less profits compared to 2016.
The company’s strategy of engaging more loan receivables may be risky, but Synchrony’s balance sheet along with its experience to carry through tough times brought by its tenure in the financial services industry may alleviate some concern.
Synchrony did carry a leveraged balance sheet at 1.44 times debt-equity ratio but has been amazingly brilliant in generating bountiful free cash flow (absent capital expenditures) in recent years. Investors should keep an eye for future increase in shareholder payouts (including buybacks) in the ensuing years brought by this cash flow generation.
Analysts have an overweight recommendation on Synchrony’s shares with an average target price of $36 per share. Multiplying average revenue estimates and three-year P/S average followed by a 20% margin indicated a per share figure of $35.
Synchrony’s shares climbed 4.82% to $31.07 after market close post reports that Berkshire took a stake in the company. Should investors think there could be more upside, then buying a few just to ride with the greatest investor of all time may not hurt.
Meanwhile, Berkshire’s estimated buy price was $29.77 at the time of writing, and there is no guarantee that Berkshire will still have the same amount of shares in the coming quarters. There is also evidence that investors should not just blindly follow Berkshire Hathaway or other well known investors to gain spectacular investment results.
In summary, Synchrony is a buy with $35 target price.
Disclosure: I have Synchrony Financial and class B Berkshire Hathaway share/s.
