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  • Writer's pictureArbat Capital

Consumer Finance Report - May 2024

US consumer finance companies were roughly flat vs the broad market in April after a notable outperformance in March, which still remained the only month of better dynamics for consumer finance companies since the beginning of the year. So, there were just three months of outperformance over the last 9 months.



EXECUTIVE SUMMARY


US consumer finance companies were roughly flat vs the broad market in April after a notable outperformance in March, which still remained the only month of better dynamics for consumer finance companies since the beginning of the year. So, there were just three months of outperformance over the last 9 months. However, consumer finance (CF) companies ended April in the red, for the first time over the last 6 months. Thus, consumer finance companies decreased by 4.1% MoM in April after a growth of 6.3% qoq in 1Q24. An average monthly price change over three previous years was -0.1% MoM. In turn, consumer finance companies increased by 41.6% yoy (as of May 14, 2024) vs +27.2% yoy of SPX index. Nonetheless, outperformance in 2023 isn’t a good sign for consumer finance companies’ dynamics in 2024. At least during the last 6 years, outperformance and underperformance years of consumer finance companies strictly alternate. Variability of US consumer finance companies decreased slightly in April, despite a start of the 1Q24 earnings season. The difference between the best and the worst performers was 48.2% in April vs 53.1% in March.  Nonetheless, it remained quite high albeit notably below variability levels of November and 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 in recent months. The key question is how deep fundamentals deterioration could be. Under the current ‘soft landing’ scenario, valuations of CF companies look roughly fair, in our opinion, as a result of significant outperformance of our sample yoy and rate expectations growth ytd. Thus, median P/B of our sample was 1.35x (as of May 14, 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 57% while an average figure since 2014 year is 48%. Median P/E of the sample was 10.7x (as of May 14, 2024) vs an average figure since 2014 year of 10.6x. Median P/S of our sample was 1.12x (as of May 14, 2024) vs an average figure since 2014 year of 1.6x. So, the current discount to SPX’s P/S is 60% while an average figure since 2014 year is just 24%. On the other hand, median EV/EBITDA of our sample was 7.9x while an average figure since 2014 year was just 8.0x. So, the current discount to SPX index of 48% is already notably higher than on average since 2014 of 38%.

The US economy continues growing well above expectations even despite 1Q24 GDP missed expectations markedly. Thus, US GDP increased by 1.6% qoq at annualized in 1Q24 vs the consensus of 2.5%. But the headline miss was mainly driven by inventories and trade while the key driver of GDP growth – consumer spending growth – remained quite strong. Moreover, even despite the miss, the actual growth rate was much higher than December’s projection of just +0.6% qoq. Also, US macro indicators revealed ytd still remained strong, implying that the US economy would continue going up at a solid pace in the remaining quarters of 2024, albeit slower than in 2H23. At least, according to the current market expectations, US GDP will increase by 1.7%/1.3%/1.5% qoq in 2Q/3Q/4Q of 2024, respectively (vs December’s projections of just +0.3%/+0.9%/+1.5% qoq). Hence, the probability of recession in the nearest year has already been estimated at just 30%. But the flip side of higher than expected GDP growth coin 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 September meeting with total cut of around 40 bps till the end of the year, implying that financial health of US consumers will remain under meaningful pressure in the nearest future. So, 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. Despite the macro situation for US consumers improved considerably in recent quarters, risks still tilted to the downside, especially in case of faster deteriorating of the labor market. The latter remained strong, even taking into account lower than expected payrolls in April, but with more and more signs of gradual cooling.

The 1Q24 earnings season of US consumer finance companies was significantly stronger than expected, but it didn’t change estimates dynamics radically, at least yet. Thus, 12 out of 17 companies from our sample for which estimates were available beat EPS consensus with a median surprise of +12.4%. Revenues were better for 15 out of 17 companies with a median surprise of +3.2%. Even taking into account relatively weak EPS/revenue dynamics till the start of the earnings season, market perception of the results was quite optimistic, thanks first of all to relatively weak CF’s quotes growth until recently. Nonetheless, estimates dynamics remained weak even after better than expected earnings. Thus, revenue estimates of companies from our sample increased by 0.3% for 2024 year but -2.9% ytd for 2025 year. Moreover, a median decline of EPS CY estimates of companies from our sample was -4.4% ytd as of May 13, 2024 vs just -1.2% ytd as of the end of February while a median decline of FY25 EPS estimates was 2.5% ytd. Nonetheless, given resilience of the US economy, the still strong labor market and the ongoing decline of recession probability, the first signs of US consumer financial health improvement have already appeared recently. At least, the speed of deterioration of fundamentals decelerated notably in recent months albeit the overall picture remained mixed so far. On the other hand, banks continued tightening lending standards for all major consumer credit categories in 1Q24, for the 6th consecutive quarter. However, a lower net share of banks tightened standards in 1Q24 vs 4Q23. Moreover, banks expect that loan demand will improve in 2024 albeit credit quality will continue deteriorating. Nonetheless, consumer loan growth continued decelerating but at slower speed – it increased by 1.6% yoy as of May 1, 2024, or +0.7% ytd. But all this growth was delivered solely by credit cards, while the rest segments continue to decline on a yoy basis, and even accelerating in recent months. In turn, credit quality indicators remain solid so far due to debt service ratios still remain quite healthy and low from a historical point of view but deteriorating relatively fast, especially for non-mortgage loan categories. However, low-end customers have already been under significant stress, which will only intensify in the near future, taking into account interest rate expectations dynamics ytd. Moreover, regulation continues to tighten for CF’s companies.

Consumer finance fundamentals remain resilient so far albeit with limited opportunity to improve in the near future. In such environment, notable re-rating of the segment looks unlikely due to ongoing growth of pressure on financial health of an average US consumer, even taking into account that key multipliers still 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 - May-2024
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