top of page
Search
  • Writer's pictureArbat Capital

Consumer Finance Report - February 2024

US consumer finance companies underperformed the broad market slightly in January, after two consecutive months of significant outperformance. So, it was the 4th time of underperformance over the last 6 months. In turn, there were just 3 months in the red on an absolute basis since March 2023, when consumer finance companies tumbled by 11.8% MoM, underperforming the broad market by 14.8% MoM.



EXECUTIVE SUMMARY


US consumer finance companies underperformed the broad market slightly in January, after two consecutive months of significant outperformance. So, it was the 4th time of underperformance over the last 6 months. In turn, there were just 3 months in the red on an absolute basis since March 2023, when consumer finance companies tumbled by 11.8% MoM, underperforming the broad market by 14.8% MoM. Thus, consumer finance companies were flat in January vs +1.6% MoM of SPX index, after they skyrocketed by 18.8% MoM in December. Average monthly decline over three previous years was -0.1% MoM. So, consumer finance (CF) companies increased by 13.1% yoy (as of January 31, 2024) vs +18.9% yoy of SPX index. Nonetheless, outperformance in 2023 isn’t a good sign for CF companies dynamics in 2024. At least, in the last 6 years, outperformance and underperformance years in performance of CF companies strictly alternate. However, volatility of US consumer finance companies tumbled in January despite the start of the 4Q23 earnings season. Moreover, it was the second consecutive month of volatility decline and it was the lowest one over the last 4 months. Thus, the difference between the best and the worst performers was just 29.8% in January vs 70.9% in December and 89.3% in November. January volatility was mainly driven by UPST, which decreased by 22.3% MoM after skyrocketing growth in December.

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 somewhat in recent months. The key question is how deep fundamentals deterioration will be. Under current ‘soft landing’ scenario, CF companies already look slightly cheap, in our opinion, even after significant outperformance in November and December. Thus, median P/B of our sample was 1.46x (as of January 31, 2024) vs an average figure since 2014 year of 1.72x and current SPX’s P/B of 4.55x. Moreover, the current discount to SPX’s P/B is 68% 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 60% while an average figure since 2014 year is 48%. Median P/E of the sample was 9.4x (as of January 31, 2024) vs an average figure since 2014 year of 10.6x. Median P/S of our sample was 1.15x (as of January 31, 2024) vs an average ratio since 2014 year of 1.6x. So, the current discount to SPX’s P/S is 56% while an average figure since 2014 year is just 23%. On the other hand, median EV/EBITDA of our sample was 11.7x as of January 31, 2024 while an average figure since 2014 year was just 8.0x. So, the current discount to SPX index of 22% is noticeably lower than an average since 2014 of 37%.

The US economy continued growing well above expectations in 4Q23, and recent macro data implied that it would remain much stronger in 1H24 than it was expected few quarters ago. Thus, despite still elevated rates, relatively high inflation, inverted yield curve since 3Q22 and tightening lending standards, US GDP increased by 4.9% qoq and 3.3% qoq at annualized rate in 3Q23 and 4Q23, respectively, vs 2.7% qoq and 2.6% qoq in 3Q/4Q22. Moreover, US macro indicators revealed ytd were notably stronger than expected, implying that the US economy would continue going up at a solid pace albeit slower than in 2H23. Hence, the probability of recession during this year has already been estimated below 50%. And it is expected that the US GDP will increase by more than 1.5% yoy in both 2024 and 2025. In turn, after significant decline of the rate expectations in 4Q23, driven by dovish Fed’s meetings accompanied by lower inflation data, the rates moved notably back in January and February, driven by quite strong payrolls. So, the first rate cut is currently expected at the May meeting with a total cut of 100 bps till the end of the year, implying that financial health of US consumers will remain under meaningful pressure in the nearest future. In other words, we believe that the worst is over for the US economy, taking into account all the risks realized in the recent years. Hence, we also think that it is too early to say that the US economy has already been completely out of the woods and that inflation battle has already gained. Moreover, even the ‘soft landing’ scenario isn’t the ‘blue sky’ one for the CF 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 remarkably in recent quarters but risks still tilted to the downside.

4Q23 earnings season wasn’t strong for US consumer finance companies. So, even despite relatively optimistic FY24 outlooks, market perception of the results was quite restrained. Given resilience of the US economy, the quite strong labor market and higher probability of ‘soft landing’, the first signs of US consumer financial health improvement have already appeared. At least, the speed of deterioration of fundamentals slowed down notably in recent months albeit the overall picture remained mixed. The start of the easing cycle will further help to improve US consumer financials, taking into account that consumer interest rates have recently been at multi-year highs. Nonetheless, the 4Q23 earnings season of CF companies was relatively weak so far, especially against the background of the strong rally in the last quarter of 2023. Thus, just 6 out of 11 companies from our sample, which revealed 4Q23 results at the moment, beat consensus with a median surprise of +1.6%. Revenues were better for 7 companies with a median surprise of +0.6%. It is also worth recalling that estimates have been revised down. Unsurprisingly, market reaction on the results was quite restrained, even taking into account relatively optimistic 2024 guidance. And although the latter does not contradict at all what we observe in the US economy at the moment, prospects of CF fundamentals still look challenging in the near term, even taking into account 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. Moreover, banks expect that loan demand will improve in 2024 albeit credit quality will continue deteriorating. Hence, consumer loan growth continued decelerating but at slower speed – it increased by 3.1% yoy as of the end of January 2024, +0.7% ytd. However, all this growth was caused solely by credit cards, while the rest of the segments continue to decline on a yoy basis albeit at slower speed in recent months. Nonetheless, debt service ratios still remain strong and quite low from the historical point of view, mainly due to active refinancing of mortgage loans during the period of ultra-low rates. So, credit quality indicators remain solid so far, but a number of them have already exceeded the pre-pandemic levels. Moreover, we expect that credit quality indicators will continue deteriorating across the board in the near future, even despite a notably faster growth of the US economy vs our expectations a quarter ago.

Consumer finance fundamentals remain resilient so far albeit with still limited opportunity to improve in the near future. In this environment, re-rating of the segment looks unlikely, especially taking into account relatively high risks and still cautious investor sentiment even despite key multipliers remain lower than historical averages. Nonetheless, there were already some early signs of stabilization recently – 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.


AC - Consumer Finance Report - Feb-2024
.pdf
Download PDF • 745KB

Comments


bottom of page