|Shares Out. (in M):||484||P/E||8.27||7.21|
|Market Cap (in $M):||9,064||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
Ally Financial is the legacy General Motors captive financial arm (formerly known as GMAC). GM sold 51% of the business to Cerberus in 2006 for $14 bn. During the financial crisis a spike in defaults, especially in the ResCap mortgage business that had been started in the mid-80s, resulted in the government injecting $17 bn into the company as part of the TARP. Since the crisis, ALLY has significantly restructured the business and now operates in two main segments:
1. Auto financing (asset side of B/S): Ally originated ~$41 bn of consumer loans for new, leased, and used cars in 2015. In addition to consumer financing, Ally provides dealer fleet financing and insurance (~30-35% of outstanding loans)
2. Online bank (liabilities side of B/S): Ally runs leading online bank with 1.1 mm customers and $55 bn deposits, making it a top 30 bank in U.S.
Ally has equity traded on the NYSE with a market cap of $9.1 bn, representing 0.7x TBV and 7.2x 2017E EPS.
Why Does Opportunity Exist?
Ally is trading at a significant discount to TBV for 3 primary reasons:
1. Auto cycle concerns: SAAR peaked in late 2015 at 18.1 mm, above pre-crisis levels, and recent releases have been down up to 5% since then. Declining auto sales could impact Ally’s ability to maintain / grow originations. In addition to sales, there is concern over potential deterioration in credit quality in the auto sector. This is particularly in the sub-prime sector, which some believe could be akin to the sub-prime mortgage bubble.
2. Loss of GM & Chrysler business: GM & Chrysler made up ~87 of originations in 2012. Since then, both have moved to shift significant business to their captive financing arms (Chrysler subvent in 2013, GM subvent and leases in 2015), which poses a headwind to Ally’s ability to continue to grow originations
3. Continued bailout overhang: Ally doesn’t “screen well” due to large restructuring expenses, high cost debt and preferred equity, and inability to distribute funds to common equity holders due to government regulations. These legacies of the crisis will be running off by the end of 2016
· Post-restructuring, ALLY has a very strong balance sheet
o Auto loans among best consumer credits and had lowest default rate in crisis (<3% vs. 5.5% for mortgage, 9% credit card)
o ~85% of ALLY’s consumer auto loans are to prime borrowers
o Nearly half (and growing) of funding from low cost deposits, which give Ally an advantage vs. debt-funded competitors
· TBV should grow meaningfully in near-term as final stages of restructuring are completed
o Ally paid down most of government preferred equity in 2015 (remainder in ’16), adding ~$0.24 to EPS going forward
o Nearly $800 mm of “repositioning” costs in last 3 years will allow for a much lower efficiency ratio going forward
o Additional $7 bn of high cost debt that will be refinanced over time, adding $0.34+ to EPS
o Capital returns to common are beginning 2H16 via share buybacks and dividends ($0.08/sh payable in Aug 2016)
· Concern over auto credit quality overblown – difficult to imagine Ally’s TBV declining even with a credit crisis repeat
o Biggest concerns in sub-prime space, where Ally has a very small presence
o Competitors much more exposed to sub-prime – possible competitive advantage if Ally able to better weather downturn
o Even if a repeat of crisis happens, provision would rise to ~2% and Ally would still have positive net income, flat / growing TBV, and would be worth today’s stock price at 0.6x TBV
Where Could We Be Wrong?
While Ally is well situated to weather a potential downturn in the auto cycle, a large decline in auto sales and deteriorating credit quality would likely weigh on the stock. Ally could experience a period of low / zero net income if required to raise provisions substantially, and this would likely cause the company to delay capital returns to shareholders. In that environment, the stock could continue trading at a discount to TBV.
Ally is also facing significant competition in the fragmented auto financing space. While it is the market leader, it has only ~6% market share and competes with a number of large banks and auto companies’ captive financing arms. If auto manufacturers (especially GM and Chrysler) try to direct more volume to their captives, it could hurt Ally’s ability to grow. In that environment, Ally may need to look elsewhere to grow its loan portfolio, and expanding outside its core competency in prime auto loans could present a challenge.
- 3Q and 4Q earnings will show continuing modest/contained exposure to subprime auto
- Return on tangible common equity (ROTCE) will trend towards low-teens, catalyzing P/TBV multiple expansion
- Dividends ($0.08c/ sh payable in August) and share buybacks
- Shareholder rotation into investors that value the stable cash flow stream, dividends, diversified banking model, at higher P/TBV and P/E multiples
|Subject||Quantifying the Downside|
|Entry||08/09/2016 05:56 PM|
Have you attempted a granular model of how the turning of the auto cycle would affect ALLY?
I have seen several sell-side models (as well as CCAR) show that even a "severely adverse" scenario would only be a 1-2 year blip in ALLY's earnings, but I've not been satisfied with how those analyses treat residual values (i.e., it is not clear to me that these models are capturing the negative feedback loop that would occur in such a scenario).
On a related note, how much would you speculate that the market's low valuation of ALLY is due to:
a) a granular, nuanced understanding of how ALLY's earnings & equity would be impaired by a turn in the auto cycle
b) a vague desire to avoid auto credit
c) terminal value fears stemming from a driverless car future