Synchrony Soothes Some Concerns

Synchrony Financial (NYSE: SYF) reported fourth-quarter results on Friday morning and the stock gained about 3%. The share price had declined a little in recent days, probably due to investor concern that the company may announce some credit-deterioration news, which could lead to a sharp price drop after.

They remember that in April of last year, such an announcement caused a 16% fall the next day. But, even after that fall, the share price recovered and the stock now trades near an all-time high. And as the 3% gain shows, investors liked this quarterly reports a lot better.

Quarterly Results Indicate Growth on Track

For the quarter, Synchrony reported net interest income (revenue) of $3.92 billion, up 8% year-over-year. Earnings per share, adjusted for a one-time $160 million negative impact from the new tax act, was $0.70. Including the impact of the tax act, EPS is $0.49. Both EPS measures were better than expected. Regarding the tax impact, due to the reduction in corporate tax rate, Synchrony adjusted downward the value of its net deferred tax asset.

Loan receivables grew 6% to $82 billion, purchase volume 3% to $37 billion, and deposits 9% to $56 billion. Net interest margin improved to 16.35%, beating the company’s own guidance. The company did set aside about 25% more reserves as provisions for loan losses compared to a year ago, but that was expected. Its efficiency ratio, a measure the ratio of costs to revenue, fell to 30.3% from $31.6% a year ago (a good thing).

Loan Quality Trending as Expected

In terms of credit quality, a key area investors are watching for, loans that are 30 or more days overdue as a percentage of loans were 4.67%, compared to 4.32% from the fourth quarter of 2016. Net charge-offs (NCO) as a percentage of average loan receivables were 5.78%. For the entire 2017, the NCO metric was 5.37%, in line with the company’s previous guidance.

For 2018, Synchrony guides to a net charge-off ratio of 5.5% to 5.8%, which would be higher than 2017 and probably a little higher than many investors hoped for. Earlier, management had said it expected the NCO ratio to be in the low 5% range in the first half in 2018 and then leveling off in the second half.

However, on the conference call, management sounded quite positive, raising hope that its current guidance may turn out to be conservative. It noted that thanks to tighter loan requirements it implemented in 2016, purchases by customers with higher credit scores are growing while purchases by customers with lower scores are falling. This suggests that the credit quality of its loan portfolio will continue to improve over time.

Outlook Attractive

We like Synchrony for its low valuation and growth potential higher than that of its peers. The company has built a strong balance sheet and has a diverse source of funding, including growing consumer deposit. And while defaults on existing loans has been increasing modestly, the company’s stricter loan requirements mean that new loans on average will be of higher quality. One good thing to note is that the stricter requirements do not seem to have slowed down loan activity.

Synchrony also figures to be one of the biggest beneficiaries of the newly lowered corporate tax rate to 21%. Its previous effective tax rate was about 37%.

The company’s partnership with Paypal should close some time in the second half of the year, and the addition of the Paypal portfolio should drive loans receivables growth into the mid teens.

Synchrony also expects loan deterioration to stabilize, and future loan loss reserves will be more driven by growth (i.e., increase of loan receivables) rather than worsening of credit. So that’s a good sign for investors.

We up our suggested buy-up-to price modestly to $42.

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