US consumer finance companies outperformed the broad market again in May 2023, for the second consecutive month after quite weak dynamics in March, when median underperformance of our group of companies was -14.8% MoM.
EXECUTIVE SUMMARY
US consumer finance companies outperformed the broad market again in May 2023, for the second consecutive month after quite weak dynamics in March, when median underperformance of our group of companies was -14.8% MoM. Thus, median growth of consumer finance companies on an absolute basis was +4.9% in May vs +0.2% MoM of SPX index. It was noticeably higher growth than average monthly performance over three previous years of -0.1% MoM. Despite the quite strong start of the year for consumer finance companies, which skyrocketed by 19.3% MoM in January 2023, outperforming the broad market by 12.4%, the sector growth remained roughly in line with SPX index growth ytd as a result of quite weak dynamics in February and March because of the regional banking crisis. Recall that in two of the three previous years, the sector showed weaker growth than the broad market. Despite quite weak performance in February and March, just 2 out of 19 companies in our sample remained negative ytd. Thus, SLM decreased just by 0.9% ytd as of June 20, 2023, while SYF lost 0.5% ytd. The dynamics of US consumer finance companies were volatile again in May 2023, which is quite typical for the last years. May 2023 dispersion of absolute monthly performance was the highest one since the January 2021. Thus, the difference between the best and the worst performers was 119.2% in May.
Given growth of recession risks in the recent quarters, consumer finance companies continue trading with a significant discount both to historical averages and to S&P 500 index. The key question is how deep a recession will be, if at all. In case of a mild recession, which is our baseline scenario at the moment, majority of companies of the segment look cheap, from our point of view. Thus, median P/B of the sample was just 1.1x (as of the end of May 2023) vs the average figure since 2014 year of 1.7x and current SPX’s P/B of 4x. Moreover, the current discount to SPX’s P/B is 73%, while the average figure since 2014 year is just 48%. A similar pattern is observed with respect to other key multipliers. Thus, the current discount to SPX’s P/E is 63%, while the average figure since 2014 year is 47%. Median P/E of the sample was just 7.5x (as of the end of May) vs the average figure since 2014 year of 10.8x. Median P/S of the sample was 1.0x (as of the end of May) vs the average figure since 2014 year of 1.7x. So, the current discount to SPX’s P/S is 58%, while the average figure since 2014 year is just 22%. On the other hand, median EV/EBITDA of our sample was 12.5x as of the end of May, while the average figure since 2014 year was just 7.8x. So, the current discount to SPX index of just 9% is noticeably higher than the average since 2014 of 38%.
Contrary to all fears, the consequences of regional banking crisis both for US economy and consumer finance fundamentals were very limited, at least so far. So, the companies in the sector continue to recover their positions after significant underperformance in February and March. Taking into account better than expected 1Q23 earnings as well as still a few signs of any significant deterioration of sector fundamentals, we fully admit that outperformance of consumer finance companies could continue in the near future even despite the more hawkish FOMC meeting in mid-June, but we don’t expect it to last long. Thus, loan growth still remains healthy despite very high and still growing rates as well as gradual cooling of the economic activity. Nonetheless, the growth is decelerating – consumer loans increased by 7.7% yoy (as of June 7, 2023) vs +12.5% a year ago. Moreover, auto loans were already negative both on yoy and MoM bases at the end of May 2023. Although majority of rates are at multi-decade highs, DSR ratios are still healthy, remaining below pre-pandemic levels, mainly due to active refinancing of mortgage loans during the period of ultra-low rates. So, credit quality remains quite strong, but it continues normalizing. Thus, NCO ratio of consumer loans increased by 10 bps qoq, or +76 bps yoy, to 1.75% in 1Q23, still noticeably below pre-pandemic levels. On the other hand, we expect that it will continue going up in the near future given still expected recession in 2H23 and the inevitable growth of unemployment in this case, albeit not as significant as expected a couple of quarters ago. The cancellation of student loan moratorium and resumption of student loan payments as early as in August 2023 will have an additional negative impact on both consumer spending and consumer credit quality in the nearest quarters, but we don’t expect that it will lead to any significant deterioration of consumer finance fundamentals, especially taking into account current projections of US GDP growth for the nearest years. Nonetheless, banks do not look very optimistic at the moment and continue to tighten lending standards because of a less favorable or more uncertain economic outlook as well as reduced tolerance for risk, deterioration in customer collateral values, and concerns about banks' funding costs and liquidity positions.
Consumer finance fundamentals remain resilient despite gradual deceleration of the economy, elevated inflation and still quite high interest rates. Growing recession risks imply further deterioration of the fundamentals in the near term, but it seems that it has already priced in, especially taking into account that the recession isn’t expected to be deep. In turn, key multipliers still remain near multi-year lows. So, we remain neutral on the sector as potential rewards are balanced by risks at the moment, from our point of view. Nonetheless, price reaction of some consumer finance companies on 1Q23 earnings imply that the sector has already reached the bottom, but for sustainable growth, faster economic growth is needed.
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