It is that time of the year again. Over the past week, the 13F filings of the world’s best investors have been published, revealing the holdings they bought, sold and maintained in the third quarter.
These releases are always highly informative, but should be viewed with a degree of skepticism. The 13F only accounts for equity holdings and does not note a hedge fund’s cash weighting or other asset holdings, so it is only part of the picture.
What’s more, these filings are backward-looking; there is always a chance the investment thesis could now be out of date.
That is not likely for long-term holders such as Warren Buffett (Trades, Portfolio), however.
Last quarter, Synchrony Financial (SYF, Financial) showed up in Buffett’s portfolio. As the holding was less than 1% of the overall equity portfolio, it is likely the position was initiated by his stock-picking lieutenants, Ted Weschler and Todd Combs. Even so, it was an interesting buy as Seth Klarman (Trades, Portfolio) also has a stake.
According to the latest 13F from Berkshire, the Synchrony holding has been increased by 19% to 20.8 million shares, which puts it on par with Klarman’s holding of 29.3 million shares.
I have covered Buffett and Klarman’s interest in Synchrony several times before.
On both occasions, I reached the same conclusion: Synchrony is a highly profitable, well-capitalized company that is undervalued and focused on investor returns. For example, as I wrote in August:
“Synchrony has one of the strongest balance sheets in the financial sector with an estimated Common Equity Tier 1 ratio under Basel III rules of 17.4% and total liquidity of $22 billion, or 24% of assets at the end of the fiscal second quarter. What’s more, at the end of the second quarter, the company reported deposits of $53 billion, comprising 72% of funding.
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The company is also extremely profitable with a net interest margin of 16.2% at the end of the second quarter and return on tangible common equity of 15.9% for the first half of the year. Management is looking to return some of the company’s enormous cash balance to shareholders. At the end of the second quarter, Synchrony announced a new $1.6 billion share repurchase program (6.6% of market value) and increased the quarterly dividend to 15 cents per share, for an annualized yield of 2%.”
This trend continued into the third quarter. Deposits grew to $54 billion, up $5 billion, or 9%, and comprised 73% of funding compared to 71% last year while the estimated Common Equity Tier 1 ratio under Basel III subject to transitional provisions was 17.3%.
For the quarter, return on assets was 2.4% and return on equity was 15.3% with the net interest margin increasing 40 basis points to 16.74%.
The one overhang that is holding Synchrony back is credit quality. At the beginning of the year, the company announced it was taking a higher-than-expected charge for credit defaults, and it is widely expected the business will have to increase provisions further as rates rise.
Nonetheless, so far, stress has been contained, but defaults are growing. Loans more than 30 days past due as a percentage of total period-end loan receivables were 4.80% compared to 4.26% last year for the third quarter, while the allowance for loan losses as a percentage of total period-end loan receivables was 6.97% compared to 5.82% last year. These are still within the provisioned limits and manageable with Synchrony’s strong balance sheet.
Synchrony’s investment case has not changed much over the past few months. The business is still a highly profitable, well-capitalized company, undervalued and focused on investor returns, which is, it seems, why Berkshire increased its position in the stock.
There is also a growth story going on here. For the third quarter, the company reported an increase in net interest income of 11% from the third quarter of 2016 to $3.9 billion. Today, management announced a deal to buy $5.8 billion in loans directly from PayPal (PYPL, Financial) and approximately $1 billion in “participation interests” in PayPal consumer loans from Comenity Capital Bank and a pair of institutional investors. Roughly 9% of the $76.9 billion in loan balances Synchrony held at the end of the third quarter. This seems to be a sensible deployment of capital. According to management, the loan portfolio PayPal is selling to Synchrony will generate about $1 billion in revenue for 2017.
Disclosure: The author owns shares of Synchrony Financial.
