US consumer finance companies underperformed the broad market in May after roughly in-line dynamics in April. So, March still remained the only month of outperformance for consumer finance (CF) companies since the beginning of the year. Moreover, there were just three months of outperformance over the last 10 months.
EXECUTIVE SUMMARY
US consumer finance companies underperformed the broad market in May after roughly in-line dynamics in April. So, March still remained the only month of outperformance for consumer finance (CF) companies since the beginning of the year. Moreover, there were just three months of outperformance over the last 10 months. Nonetheless, consumer finance companies ended May in the green, for the 6th time over the last 7 months. Thus, they increased by 1.7% MoM in May after a decline of 4.1% in April and a growth of 6.3% qoq in 1Q24. An average monthly price change over three previous years was -0.1% MoM. In turn, consumer finance companies increased by 23.3% yoy (as of June 10, 2024) vs +24.7% yoy of SPX index. But an outperformance in 2023 isn’t a good sign for dynamics of consumer finance companies in 2024. At least, during the last 6 years, years of CF companies outperformance and underperformance strictly alternated. Variability of US consumer finance companies decreased again in May, for the second consecutive month despite continuation of the 1Q24 earnings season. The difference between the best and the worst performers was just 29.6% in May vs 48.2% in April and 53.1% in March. Moreover, the first 5 months of 2024 were the least volatile start of the year since 2020.
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 in recent months. The key question is how deep fundamentals deterioration could be from the current levels under the baseline ‘soft landing’ scenario. So, valuations of CF companies look roughly fair, in our opinion, given a more optimistic economic outlook. Thus, median P/B of our sample was 1.3x (as of June 10, 2024) vs an average figure since 2014 year of 1.71x and 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 49%. A similar pattern is observed with respect to other key multipliers. Thus, the current discount to SPX’s P/E is around 58% while an average figure since 2014 year is 48%. Median P/E of the sample was 10.5x (as of June 10, 2024) vs an average figure since 2014 year of 10.6x. Median P/S of our sample was 1.1x (as of June 10, 2024) vs an average figure since 2014 year of 1.6x. So, the current discount to SPX’s P/S is 61% while an average figure since 2014 year is just 25%. On the other hand, median EV/EBITDA of our sample was 7.7x as of June 10, 2024 while an average figure since 2014 year was just 8.0x. So, the current discount to SPX index of 51% is already notably higher than an average since 2014 of 38%.
US labor market continues gradually cooling while economic growth still remains strong albeit losing momentum. Thus, JOLTs vacancies tumbled by 296K MoM to just 8.06 mln in April, missing the consensus by 291K. It is still higher than a pre-pandemic high, and the ratio of job openings to unemployed workers remains healthy albeit declining quite fast recently, falling to just around 1.24x in April, the lowest figure over almost three years. Despite quite strong and better than expected payrolls so far, +272K in May vs the consensus of +180K, total employment tumbled by 408K in May, according to the household survey. So, unemployment rate increased by 10 bps MoM to 4.0% in May vs the consensus of 3.9%, the highest figure over more than two years. It was accompanied by weaker than expected consumer spending. Thus, real personal spending increased by 2.6% yoy, but -0.1% MoM, in April vs the consensus of +0.1% MoM and the March growth of 2.8% yoy, or +0.4% MoM. So, despite GDP growth forecasts continues going up, and probability of recession in the nearest year has already been estimated at just 30%, US consumers continue to feel a significant pressure from high interest rates and elevated inflation, especially low-end customers, whose excess savings have already dissolved. Nonetheless, according to the current market expectations, US GDP will increase by 1.7%/1.3%/1.5% qoq in 2Q/3Q/4Q of 2024, respectively (vs December’s projections of +0.3%/+0.9%/+1.5% qoq). But the flip side of the higher than expected GDP growth coin is the more hawkish Fed, mainly driven by higher than expected inflation data ytd. So, the Fed’s balance of risks is still shifted towards inflation, and the first rate cut is currently expected not earlier than in September with total cut of around 40 bps till the end of the year, implying that financial health of US consumer will remain under a meaningful pressure in the nearest future, even in case of the more dovish Fed, since the latter is likely to be caused by even more weaker labor market.
Stronger than expected 1Q24 results of US consumer finance companies were offset by higher uncertainty around further dynamics of the labor market. So, EPS/revenue estimates weren’t revised up significantly qtd. Nonetheless, given resilience of the US economy, still quite strong payrolls and an ongoing decline of recession probability, the first signs of US consumer financial health improvement have already appeared recently. Thus, credit quality pressure eased somewhat for CF companies in 1Q24 while loan growth stabilized, at least for some time. Nonetheless, the start of the monetary easing cycle, which, all other things being equal, could help US consumer financials to improve in the near future, continues to be delayed, implying higher for longer rates. 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. On the other hand, the earnings season 1Q24 of consumer finance companies was quite strong, especially against relatively weak dynamics of CF’s quotes. Moreover, FY24 management projections remained optimistic, implying peak of NCOs in the middle of the year. However, although the latter does not contradict at all what we observe in the US economy recently, prospects of CF fundamentals still look rather challenging in the near term. So, banks continued tightening lending standards for all major consumer credit categories in 1Q24, for the 6th consecutive quarter. However, a lower net share of banks tightened standards in 1Q24 vs 4Q23. Moreover, banks expect that loan demand will improve in 2024 albeit credit quality will continue deteriorating. Nonetheless, consumer loan growth continued decelerating but at slower speed – it increased by 1.5% yoy as of May 22, 2024, or just +0.9% ytd. But all this growth was caused solely by credit cards, while the rest of the segments continue to decline on a yoy basis, and even accelerating in recent months. 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 significant growth of interest rate expectations ytd. So, it seems that a 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 segment looks unlikely due to 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, which is 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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