Allied Financial (ALLY 0.22%) hard hit by deteriorating credit conditions in the auto market and rising interest rates. At Wednesday’s closing price, the auto lender’s stock was down 43% this year, more than double the nearly 20% decline for the S&P500.
Still, even with near-term earnings pressure, now could be a great time to buy Ally Financial stock if you have a multi-year time horizon. Here’s why.
Third quarter results: the good and the bad
Ally’s third-quarter earnings, reported earlier this month, were below average at best. The company’s net income was $272 million in the period, compared to $683 million in the same quarter last year. Why have revenues fallen so rapidly? There is one main reason.
With the Federal Reserve raising interest rates sharply, Ally raised the rate its depositors pay to hold money in the bank. Ally makes money by lending these deposits for auto loans and other lending products, which usually have a fixed rate over several years. So when it is forced to increase the interest rate it pays consumers, the spread it earns on the interest it pays versus the interest it receives shrinks. It’s called net interest margin (NIM). Management expects the NIM to decline to 3.5% over the next few quarters. This will affect earnings until its auto loan portfolio is repriced at higher interest rates, widening the spread.
Another thing that worries investors is the current sharp drop in used car prices in the United States. The majority of Allies car loans are for used cars, and if prices continue to fall, its lending volume could decline. On top of that, the value of the cars she takes back from people who default on her loans will go down, hurting her earning power.
Ally’s auto lending business is about to hit a rough patch, but the other side of its business, consumer banking, is doing very well. Customers increased for the 54th consecutive quarter to 2.6 million, with personal deposits reaching $133.9 billion, up $2.7 billion from last quarter and $2.3 billion from last quarter. compared to the third quarter of last year.
Ally also regularly sells new products to its consumer banking customers. For example, Ally Credit Card now has a total balance of $1.4 billion, up from $0.8 billion last year.
The consumer banking aspect of Ally’s business is vital, as it provides the company with low-cost deposits to fund its lending operations. With consumer deposits rising steadily, there’s no reason to think Ally’s earnings won’t return to an upward trajectory once interest rates and used-car prices stabilize.
Adopt the long-term vision
If you’re an investor in Ally, you have every right to worry about what might happen to its earnings in the coming quarters. But in the long run, the company looks set to succeed and return a lot of shareholder value at these prices.
At recent prices, with a market cap of around $8 billion, Ally is trading less than its book value, an important measure for a bank stock. Over the long term, management believes it can generate a 16% to 18% annual return on this book value due to its low-cost deposits and branchless model, which could lead investors to generate more than that each year. in terms of earnings if shares are purchased. below book value.
However, over the next several quarters, this return, known as the return on equity (DEER), will be lower. In the third quarter, it was only 10%. That’s not a bad ROE, but it’s lower than what management thinks Ally can generate in a normal macro environment.
The company is also generous with the money it returns to shareholders. Its dividend currently pays nearly 4.5%, and it has repurchased more than 35% of its outstanding shares since its IPO in 2014. Both could boost yields even more over the next five years or so.