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Writer's pictureArbat Capital

Consumer Finance Report - September 2024

US consumer finance (CF) companies underperformed the broad market slightly in August after significant outperformance in July. Nonetheless, August was the 5th month of weaker dynamics for US CF companies since the beginning of the year. Moreover, there were only 4 months of outperformance over the last 13 months.



EXECUTIVE SUMMARY


US consumer finance (CF) companies underperformed the broad market slightly in August after significant outperformance in July. Nonetheless, August was the 5th month of weaker dynamics for US CF companies since the beginning of the year. Moreover, there were only 4 months of outperformance over the last 13 months. Nonetheless, CF companies managed to end August in the green, for the 7th time over the last 10 months. Thus, CF companies increased by 2.2% MoM in August after a growth of 11% in July, adding 19.2% ytd as of the end of August. But an average monthly price change over three previous years was just -0.1% MoM. In turn, consumer finance companies increased by 44% yoy (as of September 5, 2024) vs +22.4% yoy of SPX. But outperformance in 2023 isn’t a good sign for dynamics of consumer finance companies in 2024. At least, during the last 6 years, years of CF companies outperformance and underperformance strictly alternated. Variability of US consumer finance companies increased notably again in August, for the second consecutive time after three months of decline, mainly driven by the 2Q24 earnings season and upcoming monetary easing. A difference between the best and the worst performers was 57.6% in August vs 52.7% in July and 21.9% in June. Nonetheless, the first 7 months of 2024 were the least volatile start of a year since 2019 while June was the least volatile month over almost 5 years. 

Given ongoing high risks as well as mixed fundamentals, consumer finance companies continue trading with discounts both to historical averages and to the broad market, but they narrowed notably in recent months. The key question is how deep fundamentals deterioration could be from the current levels, given clear signs of labor market cooling. But valuations of CF companies look roughly fair in case of ‘soft landing’, in our opinion. Thus, median P/B of our sample was 1.35x (as of September 5, 2024) vs an average figure since 2014 year of 1.7x and current SPX’s P/B of 4.9x. Moreover, the current discount to SPX’s P/B is 72% while an average figure since 2014 year is just 50%. A similar pattern is observed with respect to other key multipliers. Thus, the current discount to SPX’s P/E is around 53% while an average figure since 2014 year is 48%. Median P/E of the sample was 11.7x (as of September 5, 2024) vs an average figure since 2014 year of 10.6x. Median P/S of our sample was 1.16x (as of September 5, 2024) vs an average figure since 2014 year of 1.6x. So, the current discount to SPX’s P/S is 59% while an average figure since 2014 year is just 25%. On the other hand, median EV/EBITDA of our sample was 8.1x as of September 5, 2024 while an average figure since 2014 year was 8.0x. So, the current discount to SPX index of 51% is already notably higher than an average since 2014 of 38%.

The US labor market continues gradually cooling. It has again raised a question about sustainability of the current economic recovery. Thus, JOLTs vacancies decreased by 137K to 7.67 mln in July, the 4th decline over last 5 months, missing the consensus by 427K. It is still higher than a pre-pandemic high, but the ratio of job openings to unemployed workers has already turned below pre-pandemic levels, just 1.07x in July, the lowest figure over more than 6 years. Payrolls increased by 142K in August vs the consensus of 165K (and the revised down July figure of +89K). So, it was the 4th miss over the last 11 months. On the other hand, unemployment rate decreased by 10 bps MoM to 4.2% in August, in-line with the consensus, but still near the highest figure over more than 2.5 years. Even Fed’s balance of risks has already shifted both to unemployment and inflation rather than only inflation as it was for a long time before. Moreover, underemployment rate increased by 10 bps MoM to 7.9% in August, the highest figure over the last 34 months, having already exceeded pre-pandemic levels. Nonetheless, consumer spending remains strong, at least so far. Thus, consumer spending increased by 2.9% qoq annualized in 2Q24, an upward revision from the initial estimate of 2.3%. But it will inevitably decline in the near future given weakening of income growth. Moreover, consumer confidence wasn’t strong even against the backdrop of higher than expected payrolls in 1H24. Thus, despite a small growth of consumer sentiment in August, it was just the second growth over the last 7 months, still remaining negative on a yoy basis. So, although GDP growth forecasts continue going up (at least, until so far) and probability of recession in the nearest year has already been estimated at just 30%, US consumers continue feeling significant pressure from high interest rates and elevated inflation, especially low-end customers, whose excess savings have already dissolved.

Stronger than expected 2Q24 results of US consumer finance companies continued overshadowing by ongoing labor market cooling. Due to resilience of the US economy, at least until recently, accompanied by the still tight labor market in 1H24, the first signs of US consumer financial health improvement have already appeared. Nonetheless, recent macro developments imply that the process may be reversed in the coming quarters even in case of relatively fast monetary easing, which, all other things being equal, could be a great help for financials of an average US consumer. Moreover, considering the current state of things, a faster than expected rate cut is likely to be caused by more rapid deterioration in the labor market, which does not guarantee that US consumers will eventually benefit from such a development. Nonetheless, the 2Q24 earnings season of consumer finance companies was quite strong, which was also reflected in the recent dynamics of EPS/Revenue estimates. Thus, 15 out of 17 companies from our sample for which estimates were available beat the EPS consensus with a median surprise of +28.1%. Revenues were better for 12 out of 17 companies with a median surprise of +2.2%. Moreover, FY24 management projections remained optimistic, still implying peak of NCOs in 2H24. So, the estimates increased notably since the start of the recent earnings season. However, although the latter does not contradict at all what we observe in the US economy until recently, prospects of CF fundamentals still look rather challenging in the near term, even taking into account continuous decline of recession probability in 1H24. So, banks held on tightening lending standards for all major consumer credit categories in 2Q24, for the 7th consecutive quarter. However, a lower net share of banks tightened standards in 2Q24 vs 1Q24. Moreover, banks expect that loan demand will improve in 2H24, albeit credit quality will continue deteriorating. Also, consumer loans growth stopped decelerating recently, they increased by 1.7% yoy as of August 21, 2024, or +1.5% ytd. However, all this growth was caused solely by credit cards, while the rest of the segments continue declining on a yoy basis, but being also roughly flat in August. In turn, NCO ratio of consumer loans increased by 13 bps qoq, or +85 bps yoy, to 2.92% in 2Q24 vs 2.30% in 4Q19. Nonetheless, debt service ratios still remain strong and quite low from a historical point of view, even despite a notable growth of interest rate expectations ytd. So, it seems that the key near term driver of credit quality dynamics will be the labor market, which continues cooling relatively fast.

Consumer finance fundamentals remain resilient so far, albeit with limited opportunity to improve in the near future. In such environment, a 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.



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