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As a recession looms, a financial stock like Allied Financial (NYSE: ALLY) is a complicated investment to own. The company faces the risk of a recession as consumers are less able to repay auto loans, but also an automotive industry that is still struggling to produce enough vehicles to meet demand. My investment thesis remains ultra bullish on the auto loan company that extends beyond related loans and is not fully loaded with auto loans due to a lack of vehicle supply.
big question
Ally Financial investors face a dilemma as the company just reported near-record Q1 2022 numbers. Revenue hit $2.14 billion and EPS for the quarter topped again. $2 per share.
Despite financial reports of EPS over $8 during the TTM period, the stock now trades at just $35. As the economy faces a recession and some financial products face weaker demand, Ally Financial is focusing on an industry where supply has been limited and sales restricted.
The company posted record net financing income, but higher non-interest expenses and provisions for credit losses slightly reduced profits. While other divisions continue to generate stronger revenue streams, Ally is still primarily focused on auto finance, where high used car prices have driven up loan funding levels despite weak volumes.
The bigger question is whether credit quality becomes a bigger issue. During Q1’22, Ally Financial took a credit charge of $167 million. The company had net charge-offs of $118 million in the quarter, but retail auto delinquencies (more than 60 days past due) were just $362 million. The 30+ DPOs accounted for just 2% of auto loans at $1.6 billion. Both figures were mostly consistent with delinquency rates for the past two years.
Source: Presentation by Ally Financial Q1’22
The biggest fear is that asset quality has deteriorated in the second quarter and for the rest of the year. Ally definitely faces a bigger challenge this year after the feds helped reduce loan write-offs in the COVID recession and the company released first-quarter 22 results in mid-April ahead of aggressive loan hikes. Fed rate.
Analysts only cut 2022/3 EPS targets to $7.70. The stock only trades at 5x forward EPS targets, so those numbers need to be significantly discounted for the stock to be unattractive here.
Alongside the Q1’22 earnings call, CEO Sean Leary provided a few data points suggesting that Ally enjoyed a strong quarter, even with the challenges:
Despite low levels of inventory and new unit sales, consumer product emissions increased 14% year-over-year, demonstrating the agility and scale of our automotive business, enabling us to consistently generate volume at attractive risk-adjusted returns. Credit normalization during the first quarter was in line with expectations and retail NCOs of 58 basis points remained well below pre-pandemic levels. We continue to monitor broader market indicators of consumer health, including wage and price inflation, employment conditions and general payment trends. While the current inflationary environment will add some pressure on households, consumers are generally well positioned with healthy balance sheets.
The company continues to report supply chain issues that have left floor plan inventories low, suggesting revenue has been constrained. Such a scenario could help Ally Financial cope with a decline in demand for automobiles, although the mortgage industry will clearly struggle.
The company already has aggressive provisions for loan losses per CFO Jen LaClair during the Q1 22 earnings call:
The loan loss allowance of 2.63% or $3.3 billion is more than 2.5 times our reserve level in 2018 and approximately $700 million higher than our CECL day 1 requirement. Our CET1 level remains raised to 10%, which translates to approximately $1.5 billion in capital excess over our internal operating target and nearly $3 billion above our SCB requirements, which positions us well to support accretive customer growth and capital returns.
On the other hand, the new credit card business saw its balances jump 73% to loan balances exceeding $1 billion and allied loan volumes more than doubled to $442 million. The numbers are relatively low for an auto loan company with $11.6 billion in originations in the last quarter alone. Over time, the credit card industry will grow.
Big yields
The net payout yield continues to claim a massive net payout yield reaching nearly 25% now. The yield combines the dividend yield recently increased to $0.30 per quarter and the return net of the share buyback. Due to the stock’s recent $20+ drop, Ally Financial has a massive return just from the $600 million share buyback in the last quarter alone.
The company has been aggressively repurchasing shares and recently had a cash balance of $3.6 billion, highlighting the potential stock valuation gap. Higher interest rates with the Fed already raising the funds rate by 150 basis points and potentially more rate hikes as well as Treasury yields used to price already rising auto loans, the loan market automobiles will be volatile. Ally Financial will most likely face higher delinquencies and a mixed picture where a lack of vehicles could keep loan demand strong, but lending difficult.
The financial firm expected up to $2 billion in share buybacks this year, leaving another $1.4 billion this year. With a market capitalization of just $11.2 billion, Ally Financial could repurchase more than 10% of outstanding shares this year in the period after March.
Carry
The key investor takeaway is that Ally Financial looks exceptionally cheap and priced for a recession here, having already fallen more than 35% from peak prices. Probably the best opportunity is to wait until the company releases its second quarter 2022 results on July 19 and properly sizes auto loan expectations in the second half of the year. An investor can lose some gains on the upside, but a 20% loss can be avoided like Assets received (UPST) after cutting Q2 lenses.
