US consumer finance (CF) companies outperformed the broad market significantly in July after two consecutive months of underperformance. But July was just the second month of stronger dynamics for CF companies since the beginning of the year. Moreover, there were only 4 months of outperformance over the last 12 months.
EXECUTIVE SUMMARY
US consumer finance (CF) companies outperformed the broad market significantly in July after two consecutive months of underperformance. But July was just the second month of stronger dynamics for CF companies since the beginning of the year. Moreover, there were only 4 months of outperformance over the last 12 months. Nonetheless, CF companies ended July in the green, for the 6th time over the last 9 months. Thus, CF companies soared by 10.5% MoM in July after a decline of 1.4% in June, adding 16.6% ytd as of the end of July. But an average monthly price change over three previous years was just -0.1% MoM. In turn, CF companies increased by 25.3% yoy (as of August 14, 2024) vs +21.5% yoy of SPX index. But the outperformance in 2023 isn’t a good sign for dynamics of CF companies in 2024. At least, during the last 6 years, years of outperformance and underperformance of CF companies strictly alternated. Variability of US consumer finance companies increased notably in July, for the first time over the last 4 months, mainly driven by the 2Q24 earnings season. The difference between the best and the worst performers was 52.7% in July vs 21.9% in June and 29.6% in May. Nonetheless, the first 7 months of 2024 were the least volatile start of a year since 2019 while June was the least volatile month over almost 5 years.
Given ongoing high risks as well as mixed fundamentals, consumer finance companies continue trading with a discount both to historical averages and to S&P 500 index, but it narrowed notably in recent months, especially in July. The key question is how deep fundamentals deterioration could be from the current levels, given clear signs of labor market cooling. But valuations of CF companies look roughly fair in case of ‘soft landing’, in our opinion. Thus, median P/B of our sample was 1.28x (as of August 14, 2024) vs an average figure since 2014 year of 1.7x and the current SPX’s P/B of 4.9x. Moreover, the current discount to SPX’s P/B is 74% while an average figure since 2014 year is just 50%. A similar pattern is observed with respect to other key multipliers. Thus, the current discount to SPX’s P/E is around 56% while an average figure since 2014 year is 48%. Median P/E of the sample was 11.3x (as of August 14, 2024) vs an average figure since 2014 year of 10.6x. Median P/S of our sample was 1.1x (as of August 14, 2024) vs an average figure since 2014 year of 1.6x. So, the current discount to SPX’s P/S is 62% while an average figure since 2014 year is just 25%. On the other hand, median EV/EBITDA of our sample was 7.2x as of August 14, 2024 while an average figure since 2014 year was just 8.0x. So, the current discount to SPX index of 55% is already notably higher than an average since 2014 of 38%.
The US labor market continues gradually cooling. It has again raised a question about sustainability of the current economic recovery. Thus, JOLTs vacancies decreased by 46K to 8.18 mln in June, the third decline over last 4 months, beating the consensus by 184K. It is still higher than a pre-pandemic high, but the ratio of job openings to unemployed workers has already returned to pre-pandemic levels, just 1.2x in June, the lowest figure over more than three years. Moreover, payrolls increased just by 114K in July vs the consensus of 175K (and the revised down June figure of +179K). But it was just the third miss over the last 10 months. On the other hand, unemployment rate increased by 20 bps MoM to 4.3% in July vs the consensus of 4.1%, the highest figure over more than 2.5 years. Even the Fed’s balance of risks has already shifted both to unemployment and inflation rather than only inflation as it was for a long time before. Moreover, underemployment rate soared by 40 bps MoM to 7.8% in July, the highest figure over the last 33 months, having already exceeded its pre-pandemic level. Moreover, it was accompanied by weaker than expected consumer spending. Thus, real personal spending increased by 2.6% yoy, or +0.2% MoM, in June vs the consensus of +0.3% MoM and the May growth of +0.4% MoM, or +2.6% yoy. Of course, it is too early to draw far-reaching conclusions. But consumer confidence wasn’t strong even against the backdrop of much higher payrolls in 1H24. Thus, consumer sentiment deteriorated again in July, the 5th decline on MoM basis over the last 6 months. So, despite GDP growth forecasts continues going up (at least, until so far) and probability of recession in the nearest year has already been estimated at just 30%, US consumers continue feeling significant pressure from high interest rates and elevated inflation, especially low-end customers, which excess savings have already dissolved.
Stronger than expected 2Q24 results of US consumer finance companies were offset by higher uncertainty around further dynamics of the labor market. Due to resilience of the US economy, at least until recently, accompanied by the strong labor market, the first signs of US consumer financial health improvement have already appeared. Nonetheless, recent macro developments imply that the process may be reversed in the coming quarters even in case of the upcoming start of the monetary easing cycle, which, all other things being equal, could be a great help for financials of an average US Consumer. Moreover, considering the current state of things, faster than expected rate cut is likely to be caused by more rapid deterioration in the labor market, which does not guarantee that US consumers will eventually benefit from such a development. Nonetheless, the 2Q24 earnings season of CF companies was quite strong, which was also reflected in the recent dynamics of EPS/Revenue estimates. Thus, 15 out of 17 companies from our sample for which estimates were available beat EPS consensus with a median surprise of +28.1%. Revenues were better for 12 out of 17 companies with a median surprise of +2.2%. Moreover, FY24 management projections remained optimistic, implying peak of NCOs in the middle of the year. So, estimates increased notably since the start of the earnings season. However, although the latter does not contradict at all what we observe in the US economy until recently, prospects of CF fundamentals still look rather challenging in the near term, even taking into account a continuous decline of the recession probability in 1H24. So, banks held on tightening lending standards for all major consumer credit categories in 2Q24, for the 7th consecutive quarter. However, a lower net share of banks tightened standards in 2Q24 vs 1Q24. Moreover, banks expect that loan demand will improve in 2H24 albeit credit quality will continue deteriorating. Also, consumer loan growth stopped decelerating recently, increasing by 1.7% yoy as of July 31, 2024, but just +1.1% ytd. However, all this growth was caused solely by the credit cards segment, while the rest of the segments continue to decline on a yoy basis, but being also roughly flat in July. In turn, NCO ratio of consumer loans increased by 18 bps qoq, or +103 bps yoy, to 2.81% in 1Q24 vs 2.28% in 1Q20. Nonetheless, debt service ratios still remain strong and quite low from a historical point of view, even despite growth of interest rate expectations ytd. So, it seems that the key near term driver of credit quality dynamics will be the labor market, which continues cooling relatively fast.
Consumer finance fundamentals remain resilient so far albeit with limited opportunity to improve in the near future. In such environment, a notable re-rating of the sector looks unlikely due to an ongoing growth of pressure on financial health of an average US consumer, even taking into account that key multipliers still remain lower than historical averages. Nonetheless, there were already some early signs of stabilization recently, a necessary but insufficient condition for us to become more constructive. So, we remain neutral on the sector as potential rewards are more than balanced by risks at the moment.
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