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  • Writer's pictureArbat Capital

Consumer Finance Report - December 2023

US consumer finance companies outperformed the broad market significantly in November 2023, for the first time over the last 4 months. And it was just the 6th month of outperformance in 2023. Despite meaningful decline in March, when median underperformance of our group of companies was -14.8% MoM, consumer finance companies is outperforming again the broad market ytd.



EXECUTIVE SUMMARY


US consumer finance companies outperformed the broad market significantly in November 2023, for the first time over the last 4 months. And it was just the 6th month of outperformance in 2023. Despite meaningful decline in March, when median underperformance of our group of companies was -14.8% MoM, consumer finance companies is outperforming again the broad market ytd. Median growth of consumer finance companies on an absolute basis was +13.3% in November vs +8.9% MoM of SPX index. It was meaningfully higher growth than an average monthly decline over three previous years of -0.1% MoM. So, consumer finance companies increased by 27.7% ytd (as of November 13, 2023) vs +22.6% of SPX index. Recall that in two of the three previous years, the sector showed weaker growth than the broad market. Nonetheless, the segment still remains quite volatile. Thus, the difference between the best and the worst performers was 89% in November vs just 27% in September and 106% in July. It was mainly driven by OPRT, which continued falling down after weak 3Q23 results. So, it tumbled by 56% MoM in November. In turn, TREE skyrocketed by 33.8% MoM in November, driven by noticeable decline of the rate expectations. However, despite quite weak performance in the three previous months as well as in March, just 2 out of 18 companies in our sample remained in the red ytd (as of December 13, 2023).

Given growth of 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 still our baseline scenario at the moment, majority of companies of the segment look slightly cheap, even after their notable outperformance in November. Thus, median P/B of the sample was 1.5x (as of December 13, 2023) vs an average figure since 2014 year of 1.7x and current SPX’s P/B of 4.4x. Moreover, the current discount to SPX’s P/B is 66% while an 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 around 55% while an average figure since 2014 year is 48%. Median P/E of the sample was 10.1x (as of December 13) vs an average figure since 2014 year of 10.6x. Median P/S of our sample was 1.1x (as of December 13) vs an average figure since 2014 year of 1.6x. So, the current discount to SPX’s P/S is 57% while an average figure since 2014 year is just 23%. On the other hand, median EV/EBITDA of our sample was 11.5x as of December 13, 2023 while an average figure since 2014 year was just 7.9x. So, the current discount to SPX index of 21% is noticeably lower than on average since 2014 of 38%.

The US economy continued growing well above expectations, but it would inevitably decelerate noticeably in the coming quarters after very strong GDP growth in 3Q23. Thus, US macro indicators revealed in November and early December weren’t strong, but GDP growth forecasts continued going up. Hence, it is most likely that US GDP growth will remain positive in the nearest quarters, and the probability of the ‘soft landing’ scenario continues going up. Nonetheless, according to consensus expectations, it is still expected that a recession in the next 12 months will occur with a probability around 50%. At least, the Fed continues to adhere to the data-dependent paradigm, emphasizing at each meeting that risks are tilted to the downside and that inflation still remains unacceptably high, even despite both economic activity and inflation were notably better than expectations in recent months. However, the dovish Fed’s meeting in November accompanied by lower CPI/PPI data allows us to hope that rates will not be so high for longer as it has been implied more recently. So, rate expectations for the nearest years moved significantly down in 4Q23, implying possible easing pressure on the financial health of US consumer. Definitely, the lags with which monetary policy affects economic activity and inflation might still be unpleasantly surprising. Nonetheless, inflation is moving in the right direction in 2H23 albeit the battle still is far from the Fed’s outright victory while GDP growth remains above expectations. On the other hand, there are more and more signs of gradual softening of the labor market in recent months, implying inevitable growth of unemployment from the current very low levels, which will affect the financial health of US consumers, especially low-end customers, even in case of ‘soft landing’, in particular, because expectations for rates, although they have decreased, still remain quite high.

The US economic outlook will remain the key driver of consumer finance fundamentals in 2024. At least, the recent rally of consumer finance companies, driven by decline of rate expectations, implies that valuations priced more severe economic scenarios in, from our point of view. But we don’t think that even ‘soft landing’ will be a blue sky scenario for the segment, given relatively fast deterioration of the US consumer financial health so far, driven by still elevated inflation, high interest rates as well as deceleration of employment growth. Indeed, excess savings induced by the pandemic fiscal stimulus have already evaporated for most cohorts while consumer expenditures continued decelerating even despite the quite strong labor market and much better than expected GDP growth so far. Hence, credit quality continues deteriorating relatively fast albeit still remaining better than historical averages. Thus, according to the Fed, NCO ratio of consumer loans increased by 36 bps, or +109 bps yoy, to 2.41% in 3Q23 vs 2.35% in 3Q19. The growth was mainly driven by credit cards, which NCO ratio went up by 62 bps qoq, or 169 bps yoy, to 3.79% in 3Q23 vs 3.74% in 3Q19. Unsurprisingly, banks continued tightening lending standards for all major consumer credit categories in 3Q23, noting that standards, on net, were on the tighter ends of their historical ranges for all consumer loan categories, especially for subprime credit card and subprime auto loans. Nonetheless, contrary to all challenges, loan growth of consumer loans remained resilient so far but decelerating relatively fast in the recent months. Thus, consumer loans increased by 4.1% yoy (as of November 29) vs +11.6% a year ago. But it was driven only by credit cards growth while other consumer loan growth turned already negative yoy. Moreover, auto loans were negative both on ytd and yoy basis, the 8th month of decline in a row. So, we expect further deceleration of loan growth and continuation of credit normalization, which implies ongoing deterioration of fundamentals even in case of ‘soft landing’ and relatively tepid growth of unemployment. In case of recession, fundamentals deterioration will be even more pronounced. So, FY24 EPS estimates continue going down, having decreased by 4.4% qtd for our sample of consumer finance companies.

Consumer finance fundamentals remain resilient so far albeit with quite limited improvement opportunity in the near future. In this environment, re-rating of the segment looks unlikely, especially taking into account downside risks for the US economy and still cautious investor sentiment, even despite key multipliers still remain lower than historical averages. So, we don’t expect that the current rally in the sector will be any long-lived, given still challenging revenue environment in the segment. But we will be more constructive when the pace of key fundamentals deterioration starts decelerating. On the other hand, relatively low valuations and ‘soft landing’ imply limited downside risk either. So, we remain neutral on the sector as potential rewards are balanced by risks at the moment.


AC - Consumer Finance Report - Dec-2023
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