One of the interesting things to observe in the economy during the late upward stages of an economic cycle is consumer lending. A struggling economy usually prompts the Federal Reserve to lower interest rates in an effort to encourage more business activity. Lower interest rates mean cheaper borrowing for businesses and individuals. For the purposes of today’s spotlight, I want to focus on the consumer side of that dynamic.
When interest rates are lower, mortgages are more affordable, and so is just about every kind of credit that you or I as consumers have access to. Car loans, major credit cards, and even department store credit accounts all start to become more attractive. Perhaps the irony of this fact is that when rates are lowest, and all of these credit instruments are the most affordable, it usually means that the economy has been contracting. The Fed lowers interest rates to encourage more borrowing, and so to spur more economic activity.
At the late stage of an economic expansion, interest rates rise as the economy heats up. Part of this comes from the ease and availability of borrowing that was facilitated by lower interest rates; as demand for credit products picks up, interest rates eventually start to increase as well just as a stock that is experiencing more buying activity will usually start to see its price rally higher. Rates also start to increase at this late stage because the Fed begins raising the rates it charges to banks and lending institutions (called the Fed Funds rate) in response to signs that the economy’s growth could be starting to move more quickly that it should.
What does all of this mean for consumer lenders? It usually means that when interest rates are increasing, they’re doing pretty well, because more and more consumers are taking out loans to pay for a variety of the goods they work with. Of course, that is something of a ticking clock, because when the economy does finally start to reverse, things aren’t so great for consumers. Unemployment usually starts to increase, which also means that personal income usually drops as well.
There is no way you can argue against the fact that even with plenty of market uncertainty over the last year, we remain in a very extended period of economic expansion. One of the market drivers this week has been continued growth in earnings, and economic reports continue to show that unemployment remains at historically low levels while incomes are growing. Those are all elements that make companies like Ally Financial (ALLY) interesting as a potential investment vehicle. Formerly known as General Motors Acceptance Corp (GMAC), ALLY re-branded itself in 2010 as part of a transformation and rebirth following the financial crisis of 2008 as a consumer lender. Historically known for auto financing, the company branched into mortgage lending, insurance, and online banking. They launched their own initial public offering in 2014 and have expanded their scope even more to start including credit card lending and even wealth management (stock and option brokerage) services. They have a lot of fundamental elements working strongly in their favor; but does that make them a good buy right now? Let’s dive in and take a look.
Fundamental and Value Profile
Ally Financial Inc. is a digital financial services company. The Company is a bank and financial holding company. Its segments include Automotive Finance operations, Insurance operations, Mortgage Finance operations, Corporate Finance operations, and Corporate and Other. The Automotive Finance operations segment provides the United States-based automotive financing services to consumers and automotive dealers, and automotive and equipment financing services to companies and municipalities. The Insurance operations segment offers both consumer finance protection and insurance products sold through the automotive dealer channel, and commercial insurance products sold directly to dealers. The Mortgage Finance operations segment consists of the management of a held-for-investment consumer mortgage finance loan portfolio. The Corporate Finance operations segment provides senior secured leveraged cash flow and asset-based loans to mostly the United States-based middle market companies. ALLY’s current market cap is $10.5 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings increased by 40%, while revenues rose a little less than 3%. In the last quarter, earnings increased a little more than 9%, while sales were a little above 3%. The company operates with a very healthy margin profile, with Net Income running at 11.2% of Revenues for the last twelve months, and increasing in the last quarter to almost 14%.
- Free Cash Flow: ALLY’s free cash flow is very healthy, at $4 billion. That translates to an outsized Free Cash Flow Yield of about 38%.
- Debt to Equity: ALLY’s debt/equity ratio is 3.48, which is a high number but is pretty normal for any consumer lending company. In the last quarter, ALLY’s cash and liquid assets were about $3.77 billion while long-term debt was more than $45 billion; however, their strong margin profile does indicate that they can service their debt without any problems.
- Dividend: ALLY pays an annual dividend of $.68 per share, which translates to a dividend yield of about 2.67% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value. ALLY’s Book Value is $31.68, which means that the stock’s Price/Book ratio right now is .8. I usually sit up and take notice when I find a stock with a Price/Book ratio below 1, and seeing one that is 20% below its Book Value under normal circumstances is usually a very good thing; however in ALLY’s case, that positive number is leavened by the reality that since becoming its own publicly traded company, their historical average Price/Book ratio is also .8, which means that the stock is priced right at its fair value. It also means that the stock would have to drop down to around the $20 level before I would consider there to be a compelling valuation argument for this stock.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: ALLY has been following a long-term downward trend throughout the past year, dropping from a high a little above $31 per share. Since the beginning of the new year, the stock has rallied nearly 25% from its trend low at around $20 per share. The interesting thing about the stock’s pattern is shown by the long, gradual, downward sloping trend line from the stock’s high point around $31 a year ago and connecting the stock’s pivot highs from that point all the way to the end of the chart. That puts the stock’s most recent pivot high squarely on top of that line, meaning that the stock is currently reversing off of trend resistance. The stock’s most immediate support is a little below $24 per share, but a drop below that level could see the stock easily retest its trend low around $20 per share.
- Near-term Keys: If the stock can break above the resistance shown by the downward trend line I’ve put on the chart above, it should market a reversal of the stock’s long-term trend and could offer and interesting opportunity to buy call options or the stock outright to take advantage of a new upward trend. The current health of the economy could lend credence to that possibility; however if the economic and credit cycle begins to weaken, a positive break becomes less and less likely. A drop in price below $24 per share could offer an interesting opportunity to short the stock or to work with put options with a target exit price in the $20 price range. From a valuation perspective, this is a good company, but it isn’t at a nice price yet. A retest of the trend low would change that narrative.