ALLY Financial
Key Statistics
Ticker Symbol= ALLY
Share Price= $43.80
Market Cap= $14.8B
2021 GAAP EPS= $8.22
Earnings Yield= 18.76%
Forward Earnings Yield=15%
Tangible Book Value Per Share = $38.73
Target Forward ROE = 16-18%
Dividend Yield = 2.73%
Ally Financial Inc. (ALLY) is in an extremely strong competitive and strategic position in the U.S. banking sector. The company benefits from a lower cost profile due to being branchless, which greatly reduces the overhead burden of the legacy consumer banking franchises. Ally emerged from GM Financial when that company went into bankruptcy during the Financial Crisis. Auto Finance is still the biggest business for Ally, which is attractive in that the lending is secured, and when defaults do occur, the asset is typically repossessed in a timely manner, reducing losses. Ally appeals to a younger demographic that does most business online. The company has diversified into investments, insurance, mortgages and now credit cards. Ally’s financial profile became dramatically stronger over the last decade due to its ability to use low-cost retail deposits to fund its business, rather than expensive secured and unsecured debt sources that the company relied on prior to becoming a bank. Since 2014, the bank has doubled low-cost retail deposits, while retiring $24 billion of legacy and secured debt with a weighted average coupon of over 5%. Ally is an undervalued stock with strong long-term upside, and we are going to recommend a trading strategy to take advantage of the current volatility in the stock.
ALLY 4th Quarter 2021 Investor Presentation
Ally works with over 21,000 dealers and over 4MM auto customers across the country, providing loans, insurance and investments. Between 40% and 70% of auto customer interactions occurred digitally each month, which increases the speed and effectiveness at which the company operates, leading to strong customer experiences. 10.5MM customers use an Ally product, which is up 52% since 2014. The company has had 13 consecutive years of customer growth, with the customer base in 2021 growing another 10%, while total deposits grew to 89% of funding. The bank ended 2021 with a CET1 Capital Ratio of 10.3%, which is comfortably above its target levels, allowing for increased buybacks over the next year.
Ally had an exceptional 2021, generating $8.381B in adjusted total revenue. Full-year adjusted EPS was $8.61 and the bank recorded a core ROTCE of 24.3%. All of these number were records for Ally. Ally’s earnings yield at current prices based on TTM earnings is an astounding 18.76%. ALLY’s core PPNR has more than doubled since 2014, resulting in nearly $4.3B in 2021, which was a record. This was largely achieved by strong revenue growth, which is expected to continue for the foreseeable future.
In 2021, Ally had $46.3B of auto originations from a record 13MM decision applications. For the 4th consecutive year, origination yields were above 7%, exemplifying the leading competitive position the company has in the industry. Being that these are secured loans, funded via extremely low-cost capital, it is not surprising to see Ally’s rapidly growing profits. Credit losses have remained particularly mild, bolstered by fiscal stimulus and low unemployment, with 31 basis points of full-year retail auto net charge-offs. The pandemic/lockdowns have created considerable supply chain problems, particularly for semiconductors on new cars. This has led to dramatically higher prices for both new and used cars, due to reduced inventories.
Ally Home originations of $10.4B were more than double the prior year level. Ally Invest customer assets exceeded $17B, including 506,000 self-directed and robo accounts. Ally lending volume of $1.2B more than doubled, fueled by a 37% increases in merchant relationships across the healthcare and home improvement verticals. Ally’s new credit card unit, Fair Square, closed the year with $953MM in balances, up 25% since announcing the acquisition in October and 66% YoY. In the Corporate Finance division, held for investment balances of $7.8B grew nearly 30% YoY on strong client demand. The Commercial Finance portfolio, which includes unfunded commitments, stood at $12.7B at the end of the year. Insurance written premiums of $1.2B marked the 4th consecutive year with premiums above $1B. Auto dealers have been holding far less inventory due to the supply chain issues, which hopefully should be improving over the next few years. Ally will benefit from this with higher commercial auto loans outstanding, which historically have negligible default rates.
Ally management announced a $2B buyback authorization program for full year 2022 and a 20% dividend increase to $.30 per share. The company is forecasting an upper 3% net interest margin, as assets steadily migrate towards $200B. Credit losses are expected to steadily normalize through 2023 from current historically low levels. Ally had an immensely profitable 2021, bolstered by used car prices and strong credit. While the ROTCE is likely to drop from the 24.3% achieved in 2021, management forecasts 16-18% over the medium term, which puts it near the top of U.S. banks. Based on a year-end tangible book value per share of $38.73, the low-end of the range would generate earnings of $6.20, and I’d expect earnings to be closer to the high-end of $7 per share. The company is conservatively reserved at 2.67%, so I believe reserve releases are more likely than significant increases in reserves, excluding normal reserving for loan growth.
Clearly, the war in Ukraine and its impact on already sky-high inflation is a major risk for the global economy. $6-7 per gallon gas is likely to pressure the consumer that went into this year in a very strong balance sheet position in aggregate. The supply chain issues aren’t likely to be resolved in the near term, which should keep used car prices elevated relative to historical levels, which is good for Ally in that when a customer defaults, the underlying asset recoups much of the defaulted loan. We’ve recently seen the first 25 bps increase in the Federal Funds rate, and we should see a handful more throughout the year if the Fed’s predictions are close to accurate. Overall, these hikes are beneficial for the earnings profile of Ally, although it isn’t one of the most asset sensitive banks in the country.
At a recent price of $43.80, ALLY trades at 1.13x tangible book value, which is very cheap for a bank earning an ROTCE in the high-teens. Based on the low-end forecast of a ROTCE of 16%, ALLY trades at just 7 times this year’s earnings, and about 5 times last year’s earnings. Book value per share should continue to grow at an accelerated rate, as will earnings per share over the long-term. We saw during the Great Recession, that many people let go of their homes before they would let go of their cars because they had to get to work. ALLY has a huge opportunity to increase earnings via cross-selling its established customer network, including with its newest product credit cards. In summary, we like the stock long-term and feel like it could be a $60 dollar stock within 2 years.
Importantly, tangible book value per share will almost certainly keep growing even in a recessionary environment. This provides somewhat of a floor on the share price, barring the most severe market crashes, such as what we saw in 2020, when Ally’s stock fell below $10 in the peak of the panic. Because we aren’t overly optimistic on the global economy in 2022 mostly due to the impacts of inflation, higher interest rates, and the absence of fiscal stimulus, one conservative way to play ALLY is via the selling of cash-secured puts. Below is the trade we would suggest:
March 22nd 2022 $ALLY $43.80
Sell 1 January 23 $40 put for $4.25
Maximum risk= $3,575
Days Outstanding= 305
Target Profit= $425
Target Profit %=11.9%
Annualized Target Profit %=14.4%
Cushion % to Breakeven= 18.37%
This strategy should net you double digit returns in a company that should be solidly profitable even if we do see a near-term recession, given the already high reserve levels the bank is carrying due Covid-19 and CECL accounting, where banks are supposed to reserve for loan losses over the life of the loans. Assuming you hold the option till expiration, the stock could drop by 18.3% before you would be at your breakeven level of $35.75 per share. This means that you could nearly withstand a bear market in the stock, before it would start to dent your profits upon expiration.