Synchrony Financial Stock: Super Cheap, Even With 2024 Headwinds (NYSE:SYF)

Company & Stock Performance Not In Sync

Synchrony Financial (NYSE:SYF) common shares have reverted to their typical behavior, which is to say underperforming relative to the decent financial performance of the company. When I covered the bank last quarter, the stock was coming off a good 3 months of outperformance following the unjustified selloff in the March 2023 banking crisis. Since then, the common shares have given everything back, falling 20% in contrast to mid-single digit declines in the preferred shares (SYF.PR.A), the Financial Sector SPDR (XLF) and the S&P 500 index fund (SPY).

The horrible stock performance is out of line with the 3Q results, which show for the most part that the downfall of the consumer is either greatly exaggerated or at least delayed. Consumers are still using their cards more than ever. Purchase volume was up 7%-8% in three of Synchrony’s five market platforms, well ahead of what can be explained by inflation. Health and Wellness did even better, with 14% growth. The one exception was Home and Auto, where purchase volume was flat with last year. In addition to buying more, consumers are also carrying a higher balance and taking longer to pay it off. As a result, loan receivables were up around 15% in the middle 3 segments, up 21% in Health and Wellness, and still up 9% even in Home and Auto.

Synchrony also guided up its full year loan receivable growth estimate to 11%. The bank also narrowed its charge-off and net interest margin forecast to the middle of the original range and reduced its estimate of retailer share arrangement costs to 3.95%, below the original range.

The one weak point for growth was in the number of new accounts, which decreased 2% from 3Q 2022. That could impact receivables growth in the future. The sore spot with the market could also be the rising amount of delinquencies as a percentage of total loans. After running at unusually low levels during the pandemic years, the percent of loans that are over 30 or 90 days overdue is now running just a shade under 2019 levels. Charge-offs and the loss reserve as a percentage of total loans looks appear to have temporarily peaked, but the bank now expects charge-offs to hit the range of 5.5%-6% in 2024. This is a percentage point above current levels, but in line with the bank’s long-term underwriting standards.

Aside from the charge-off forecast, Synchrony did not make any projections for 2024 on the earnings call. Nevertheless, I have made my first estimate of 2024 performance assuming a significant slowdown in receivables growth as well as an increase in loss reserves as a percent of total loans. Even with these conservative assumptions, Synchrony common stock looks cheap at 5.1 times 2023 earnings and 4.3 times 2024. Despite the risks to the consumer, the bank looks too cheap to pass up.

Financial Model Update

I increased loan receivables growth in 2023 to 11% based on the latest company guidance but conservatively assumed only 4% in 2024. On net interest margin, I assume 15.15% in 2023 in line with company guidance, decreasing slightly to 15.1% in 2024. RSA’s fall a bit in 2024 but the big change is in credit quality. I have charge-offs increasing to 5.75% of loans in 2024 as discussed above. I also estimate an increase in loss reserves to 10.6% at the end of 2023 and 11% in 2024, up from 10.4% currently. This can be the biggest driver of results, so a conservative estimate here should provide a good margin of safety. Looking at history, we see that reserves were 11.1% of loans in 1Q2020 at the start of the pandemic. While this number grew across the rest of 2020, the bank over-reserved, resulting in releases during 2021.

Putting it all together, I now estimate full year 2023 EPS at $5.36. This is about 4.8% below my estimate in last quarter’s article, nowhere near the 20% drop seen in the stock price. For 2024, the EPS estimate is $6.36, representing 18.7% growth from 2023. With the stock selling off to $27.50 after the earnings release, Synchrony shares are at a dirt-cheap P/E of 5.1 for 2023 and 4.3 for 2024.

Turning to the balance sheet, Synchrony has done a great job retaining deposits compared to regional banks that had issues earlier this year. Deposits have even grown to 84% of funding, or 79.8% of gross loans, a fraction I assume continues to hold through 2024. The shares are trading well below end-3Q 2023 book value of $31.50, and even further below the estimates of $32.89 at year-end 2023 and $39.64 in 2024.

Synchrony has been a massive buyback machine, having already reduced share count by 5.6% in the first 9 months of 2023, on the way to a full year share count reduction of 7%. I expect a further 6% reduction in 2024. This is based on the existing buyback authorization of $850 million spread out through the end of 2024 at $170 million per quarter.

Capital Management

Synchrony has been a conservative dividend payer, with increases of $0.01 per share quarterly at mid-year 2022 and $0.02 quarterly at mid-year 2023 to a current payout of $0.25 per quarter. This represents a forward yield of about 3.6%. The models above reflect another $0.02 per share raise next year to $0.27 quarterly.

Over the past several years, Synchrony has been employing their large buybacks to get out of an overcapitalized position. Regulatory capital ratios have come down about 2 percentage points in the past year and are still not stretched, with a Common Equity Tier I capital ratio of 12.4%, now in line with peer Capital One (COF).

Looking forward, the banking regulators (Federal Reserve, OCC, and FDIC) have proposed stricter capital requirements since the March 2023 banking crisis. These kick in for banks with over $100 billion in total assets, a figure Synchrony has just exceeded in recent years. Banks would have to start phasing in the higher capital requirements in July 2025 with full implementation by July 2028. The rules have not been finalized yet and the agencies are still accepting comments through November 2023. Therefore, it is too early to know the exact impact on Synchrony, but a rough guess on the earnings call was for 20% higher Tier I capital. (In other words, about $2.4 billion CET1 capital above the existing amount of $12.1 billion) This could reduce the pace of buybacks and dividend growth or result in the issuance of more preferred stock.

Valuation

Synchrony has historically been a good buy at Price/book levels less than 1. In the past 5 years, it has only hit that level during the March 2020 covid crash as well as after the March 2023 banking crisis. It is now trading there again, although peers have been similarly beaten up.

Synchrony continues to be the cheapest of its peers on a P/E basis, although the discount to Discover (DFS) has narrowed following CEO resignation and accounting issues at that bank.

Preferred And Bonds Update

The preferred shares have declined in the past quarter, though not nearly as much as the common, and this is to be expected in a higher interest rate environment. On March 15, the preferreds closed at $14.36 for a yield of 9.8%. The 10-year Treasury yielded 3.5% at that time, resulting in a spread of 6.3%. Currently at $15.05, the preferreds yield 9.3%, compared to the 10-year at 4.85%. With the spread now at 4.45%, the preferreds are not as strong of a buy as they were in March, but they still are a good value, well-covered with no danger of missing a dividend.

Looking at individual bonds, Synchrony offers maturities from 2024 to 2031 with yields to maturity ranging from 6.6% to 8.3%. Since July, this is an increase of 60 basis points at the short end and 130 basis points at the long end. For comparison, the 1-year T-Bill yield is up about 10 basis points and the 7-year Treasury note yield is up about 100 basis points since then, so the market is pricing in a little more credit risk for Synchrony.

Deposit rates have come up 25 basis points for a High Yield Savings account to 4.75%. The highest yielding CD is now 5.4% for 16 months, compared to 5.05% for 9 months available in July, suggesting Synchrony is embracing a higher for longer rate scenario to retain deposits.

Conclusion

Synchrony continues to perform well financially despite the negative return in the stock over the past quarter. The consumer continues to spend money and carry credit card balances despite macro worries. Credit quality is expected to worsen in 2024 with higher charge offs and possible loss reserve build, but I do not see this overtaking continued growth in loan balances.

With a P/B below 1 and P/E of 5.1 times 2023 earnings, the common stock is again in Strong Buy territory. The preferreds also still look attractive but the spread to Treasuries has narrowed since the blow out following the March 2023 banking crisis. The senior notes are investment grade, and along with CD’s and savings accounts are a good choice for income investors who want their principal back on a set maturity date.