US Consumer Finance companies outperformed the broad market slightly in April 2023 after quite weak dynamics in March, when median underperformance of our group of companies was -14.8% MoM.
EXECUTIVE SUMMARY
US Consumer Finance companies outperformed the broad market slightly in April 2023 after quite weak dynamics in March, when median underperformance of our group of companies was -14.8% MoM. Thus, median growth of consumer finance companies on an absolute basis was +2.1% in April vs +1.5% MoM of SPX index. It was noticeably higher growth than average monthly performance over three previous years of -0.1% MoM. Despite a quite strong start of the year for Consumer Finance companies, which skyrocketed by 19.3% MoM in January, outperforming the broad market by 12.4%, the sector underperformed SPX index ytd as a result of quite weak dynamics in February and March driven by the regional banking crisis. Recall that in two of the previous three years, the sector showed dynamics worse than the broad market. Despite quite weak performance since mid-February, just 6 out of 19 companies in our sample remained negative ytd. However, the dynamics of US consumer finance companies was quite volatile in April 2023, the same it was in previous months. Thus, difference between the top and bottom absolute monthly performance in the sector has never fallen below 20% since the start of 2020.
Given growth of the recession 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 the recession would be. In case of a mild recession, which is our baseline scenario at the moment, majority of companies of the segment look cheap, from our point of view. Thus, median P/B of the group was just 1.1x (as the end of April 2023) vs an average figure since 2014 year of 1.7x and current SPX’s P/B of 4.1x. Moreover, current discount to SPX’s P/B is 73% while average figure since 2014 year is just 48%. A similar pattern is observed with respect to other key multipliers. Thus, current discount to SPX’s P/E is 63% while average figure since 2014 year is 47%. In turn, current discount to SPX’s P/S is 61% while average figure since 2014 year is just 21%. As for individual names, multipliers are still quite different both across the segments and even within individual segments. So, the cheapest companies remain OMF and OPRT which are trading at a significant discount to the industry average.
Despite all the shocks that have befallen the US economy recently, it still continues to grow albeit at a below-trend pace. So, consumer finance fundamentals still remain strong but gradually deteriorating. Thus, loan growth remains healthy so far in spite of exceptionally high rates and deterioration of economic activity. Nonetheless, the growth is decelerating – consumer loans increased by 8.3% yoy (as of May 10, 2023) vs +12.7% a year ago. Also, it should be noted that auto and student segments remained roughly flat ytd. Majority of rates are at multi-decade highs, but DSR ratio remains quite healthy, still below pre-pandemic levels, mainly due to active refinancing of mortgage loans during the period of ultra-low rates. So, credit quality remains quite strong, but it continues normalizing. Thus, NCO ratio of consumer loans increased by 10 bps qoq, or +76 bps yoy, to 1.75% in 1Q23, still noticeably below pre-pandemic levels. On the other hand, we expect that it will continue going up in the near future given the upcoming recession and the inevitable increase in unemployment in this case. Also, there is risks that student loan moratorium will be cancelled till the end of 3Q23, which implies an additional burden of several hundred dollars on the budget of several tens of millions of people, and further growth of NCO ratios across all consumer finance segments. So, banks do not look too optimistic in the current conditions and continue to tighten lending standards, driven by a less favorable or more uncertain economic outlook as well as reduced tolerance for risk, deterioration in customer collateral values, and concerns about banks' funding costs and liquidity positions. And risks are still tilted to the downside, from our point of view. However, we don’t expect significant deterioration of the fundamentals from current levels given still strong consumer BS’s, the quite tight labor market and the expected depth of the recession.
Consumer Finance fundamentals remain resilient despite gradual deceleration of the economy, elevated inflation and still quite high interest rates. Growing recession risks imply further deterioration of the fundamentals in the near term, but it seems that it has already priced in, especially taking into account that the recession isn’t expected to be deep. In turn, key multipliers still remain near multi-year lows. So, we remain neutral on the sector as potential rewards are balanced by risks at the moment, from our point of view. Nonetheless, price reaction of some consumer finance companies on 1Q23 earnings imply that the sector has already reached the bottom, but only if the recession is not very deep.
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