US consumer finance companies outperformed the broad market notably in March, for the first month since the beginning of the year. So, it was the third time of outperformance over the last 5 months although only the third time over the last 8 months as well (depending on who wants to emphasize what).
EXECUTIVE SUMMARY
US consumer finance companies outperformed the broad market notably in March, for the first month since the beginning of the year. So, it was the third time of outperformance over the last 5 months although only the third time over the last 8 months as well (depending on who wants to emphasize what). Moreover, it was the 5th consecutive month of non-negative dynamics for US consumer finance (CF) companies. Thus, consumer finance companies increased by 7.2% MoM in March vs +3.1% MoM of SPX index, after a growth of +1.3% MoM in February and flat dynamics in January. An average monthly price change of CF companies over three previous years was -0.1% MoM. In turn, consumer finance companies increased by 41.6% yoy (as of April 8, 2024) vs +26.7% yoy of SPX index. Nonetheless, outperformance in 2023 isn’t a good sign for dynamics of consumer finance companies’ quotes in 2024. At least during the last 6 years, years of outperformance and underperformance of consumer finance companies strictly alternated. However, variability of US consumer finance companies’ quotes increased again in March, for the second consecutive month, driven by the 4Q23 earnings season. The difference between the best and the worst performers was 53.1% in March vs 41.3% in February. Nonetheless, it remained notably below variability levels of November and December of 2023, and 1Q24 was less volatile than 1Q23 as well. Moreover, January 2024 was the least volatile start of the year in the post-pandemic period.
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 the discount narrowed somewhat in recent months. The key question is how deep fundamentals deterioration could be. Under the current ‘soft landing’ scenario, valuations of CF companies look already roughly fair, in our opinion, driven by significant outperformance in the recent 5 months. Thus, median P/B of our sample was 1.32x (as of April 8, 2024) vs an average figure since 2014 year of 1.71x and the current SPX’s P/B of 4.8x. Moreover, the current discount to SPX’s P/B is 72% 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 55% while an average figure since 2014 year is 48%. Median P/E of the sample was 11.2x (as of April 8, 2024) vs an average figure since 2014 year of 10.6x. Median P/S of our sample was 1.29x (as of April 8, 2024) vs an average figure since 2014 year of 1.6x. So, the current discount to SPX’s P/S is 47% while an average figure since 2014 year is just 24%. On the other hand, median EV/EBITDA of our sample was 11.5x as of April 8, 2024 while an average figure since 2014 year was just 8.1x. So, the current discount to SPX index of 24% is noticeably lower than an average since 2014 of 37%.
The US economy continues growing well above expectations, and recent macro data implies that it will remain much stronger in 1H24 than it has been expected until so far. Thus, according to the recent market expectations, US GDP is estimated to increase by 3% qoq at annualized rate in 1Q24. It is below than GDP growth rate in 2H23 when the growth was 4.9% qoq and 3.3% qoq in 3Q23 and 4Q23, respectively. But it is also much higher than December’s projection of +0.6% qoq. Moreover, US macro indicators revealed ytd still remained strong, implying that the US economy would continue going up at solid pace in the remaining quarters of 2024 albeit slower than in 2H23. Hence, the probability of recession in the nearest year has already been estimated at just 35%. But the flip side of the coin of higher than expected GDP growth is the more hawkish Fed, mainly driven by higher than expected inflation data in early 2024. The latter, among other things, is another indicator that the economy continues growing faster than expected. So, the Fed’s balance of risks is still shifted towards inflation, and the first rate cut is currently expected only at the June meeting with total cut of less than 70 bps till the end of the year, implying that financial health of US consumers will remain under meaningful pressure in the nearest future. The good news is that very high interest rates haven’t had a significant negative impact on the US economy yet, but the key word here is ‘yet’. Thus, even the ‘soft landing’ scenario isn’t the ‘blue sky’ one for the consumer finance companies, given still strong pressure from high interest rates and elevated inflation on US consumers, especially low-end customers, whose excess savings have already dissolved. So, the macro situation for US consumers improved considerably in recent quarters, but risks still tilted to the downside, especially in case of faster deteriorating of the labor market. The latter remained quite strong so far with much higher than expected payrolls again in March, but there were more and more signs of gradual cooling of the labor market recently.
Recent rally of US consumer finance companies wasn’t accompanied by corresponding growth of revenue/EPS estimates. So, the weaker than expected 1Q24 earnings season may lead to a correction in the segment, especially taking into account significant growth of rate expectations ytd. Moreover, regulation continues to tighten. Thus, in early March, CFPB finalized a rule which would cut excessive credit card late fees by 75%. And although for most credit card companies, the impact, especially long-term, will be more than manageable, for some, for example, Bread Financial, about a quarter of the revenue is at risk currently. Moreover, it is still quite possible that regulators will also block the potential DFS’s acquisition deal by COF, which was announced not so long ago, and which could be highly accretive for COF even despite a relatively high premium paid. Nonetheless, the good news is that the first signs of US consumer financial health improvement have already appeared recently, driven by faster than expected growth of the US economy. At least, the speed of deterioration of fundamentals decelerated notably in recent months, albeit the overall picture still remained mixed. Thus, the 4Q23 earnings season of CF companies was relatively weak, even despite the estimates had been revised down before. Thus, just 10 out of 17 companies from our sample for which estimates were available beat EPS consensus with the median surprise of +2.3%. Revenues were better for 11 out of 19 companies with the median surprise of +0.6%. And although the fact does not contradict at all to what we observe in the US economy at the moment, the prospects of CF fundamentals still look rather challenging in the near term, even taking into account an ongoing decline of the recession probability. So, banks continued tightening lending standards for all major consumer credit categories in 4Q23, for the 5th consecutive quarter. However, a lower net share of banks tightened standards in 4Q23 vs 3Q23. Also, banks expect that loan demand will improve in 2024, albeit credit quality will continue deteriorating from the current levels. Moreover, despite a much stronger economic growth than could have been expected a half year ago the majority of credit quality indicators have already exceeded the pre-pandemic levels and continue deteriorating, albeit at slower rate. In turn, consumer credit growth continues decelerating, remaining negative for all major loan categories except for credit cards.
Consumer finance fundamentals remain resilient so far, albeit with a limited opportunity to improve in the near future. In such environment, notable re-rating of the segment looks unlikely, especially taking into account their significant outperformance in the last 5 months even despite key multipliers still remain lower than historical averages. Nonetheless, there were already some early signs of stabilization recently which are 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.