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I have decided to share a portion of my interest in the consumer finance sector with the blog. I put a team together to focus on this sector before moving on to develop the next leg of my investment thesis. We have shortlisted 8 companies in the US consumer lending sector for further fundamental analysis. We will be looking more closely at these companies and reviewing their financial statements and foot notes. I'll share the procedure and two of the finalists (sounds like a beauty pageant, doesn't it?) as well as one that was booted from the list.
We selected these companies based on the following procedure:
From our initial list of 825 companies globally, we selected 525 companies by excluding 290 companies for which price information was not available and were having market cap of less than 2.5 mn. Of the remaining 525 companies, we selected 146 companies based on relevance of business in the following line of business - Credit cards consumer installment, credits loan guarantees, secured/unsecured consumer lending, real estate lending, consumer lending and financing, capital funding service, outsourced receivables management, pawn brokering services, financial guarantee insurance.
Of the remaining 146 companies we excluded 26 companies which had witnessed price decline of more than 65% over the past one year. We obtained 34 US companies (in the remaining list of 120 companies), of which 6 were excluded with market cap of less than $10 mn.
The following are 3 out of the 8 companies that were shortlisted from the list of 28 US companies for further scrutiny:
American express (AXP) :
· AXP with adjusted P/B of 6.47x trades higher than most of its peers.
· The company’s net charge-off’s to loans in 2007 was 4.0% while its total allowances to loans was 3.4% suggesting that the company might have inadequate provisioning
· AXP’s total debt to common stood at 662.3% at the end of 2007 while its leverage at 13.6x is considerably high when compared to its peer group.
Capital One (COF) :
· COF’s five year EPS growth (geometric) is at a negative of 0.3% reflecting the company’s dismal performance.
· COF’s return on equity and return on assets at 6.3% and 1.0% , respectively for 2007 is significantly lower than its peer group.
· 30 day+ delinquency rates for credit card segment increased to 4% in 1Q2008 from 3% in 1Q2007 while charge-offs for US credit card segment had increased to 5.85% from 3.72% in the comparable period.
SLM Corporation (SLM) :
· SLM’s 5 year geometric EPS and NIM growth of -6.1% and 2.2% is quite low when compared to its peer group.
· SLM has very thin NIM margin of 1.3%.
· The company is highly leveraged with leverage ratio of 29.7x and total debt to capital at 4,019% (sourced from Bloomberg)
· SLM’s total reserves at 0.8% of total loans could be inadequate to cover for future charge-offs.
· Although the stock has declined nearly 63% over the past one year its still trading at $19.4 . A further probe revealed that there was not enough meat left on the bone for significant downside potential from the current levels.
The next step was to whittle down the 8 companies chosen to a manageable chunk...
Among the 8 companies shortlisted for further scrutiny, we have looked at the first 7 and have shortlisted 3 companies based on the following observations (I'm only publsihing two for now).
Capital One:
· Note: Capital One was on my radar last year and earlier this year as having the highest default rate among its peers, but I decided to move on to other targets on both occasions. Despite the price drop and a more stringent screening process, it shows up in the scan once again. Capital One’s loan portfolio comprising credit card business, auto finance business and international business is facing problems as reflected by higher delinquency rates (30+ days) in its US credit card business, auto finance business and international business at 4.04%, 6.42% and 5.12%, respectively in 1Q2008, up from 3.06%, 4.64% and 4.78%, respectively in 1Q2007.
· Its net charge offs increased 78% to $767 mn in 1Q2008. Also, its allowances for loan losses increased 44% to $3.3 bn.
· Despite increase in delinquency and charge-offs, the company’s provisioning for loan losses seems inadequate. In 1Q2008 COF’s provision to loans were 1.10% while chare-offs to loans stood at 3.07%. Its provision to losses was consistently below its charge-off rate in the previous four quarters
· Its net interest income growth (q-on-q) slowed down drastically to 2.8% in 1Q2008 from 5.6% and 8.5% in 3Q2007 and 4Q2007, respectively.
· Non interest income growth (q-on-q) was negative 4.7% in 1Q2008 compared to 11.1%, 9.0% and 0.4% in 2Q2007, 3Q007 and 4Q2007, respectively.
· Its adjusted leverage also increased from 11.7x in 1Q2007 to 13.4x in 1Q2008
American Express (AXP)
· AXP’s ‘reserves as % of consumer receivables’ at 3.6% in 1Q2008 as against ‘loans 90 days past as % of loans’ at 4.4% reflect that the company has inadequate allowances for bad loans.
· AXP’s write-offs for consumer receivable loans have increased to 0.78% of loans from 0.62% in 1Q2007 while write-offs for Card member loans have increased to 0.74% in 1Q2008 from 0.55% in 1Q2007.
· Despite increase in charge offs and inadequate provisioning, AXP’s adjusted P/B of 6.47x seems significantly higher than its peers
· Leverage has increased from 11.7x in 1Q2007 to 14.6x in 1Q2008.
SLM corporation has also witnessed similar trend in its provision for loan losses and write offs but the stock has already witnessed around 65% decline in its price over the last 12 months. Therefore, the same has been excluded from our list of 3 shortlisted banks.
Of the above companies, AXP and Capital One appear more venerable based on initial analysis.
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Market metrics |
COF US EQUITY |
AXP US EQUITY |
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Consumer Fin |
Consumer Fin |
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Line of business |
Credit card & consumer lending |
Travel related |
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Consumer Fin |
Consumer Fin |
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Business descrption |
Capital One Financial Corporation provides a variety of products and services to consumers through its subsidiaries. The Company through Capital One Bank offers credit card products. Capital One F.S.B. provides certain consumer lending and deposit services. Capital One Services Inc. provides operating administration and other services to the Corporation. Obvious credit risk abounds. |
American Express Company through its subsidiaries provides travel-related financial advisory and international banking services around the world. The Company's products include the American Express Card the Optima Card and American Express Travelers Cheque. Exposed to credit risk and the coming consumer entrenchment and global slowdown – effected by higher fuel prices that hamper travel and lower real wages that hamper spending the proclivity to pay back loans. |
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Share price |
38.0 |
37.7 |
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Shares outstanding |
372.9 |
1,158.0 |
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Market Capitalization |
14,261.1 |
43,637.4 |
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Enterprise Value |
40,939.2 |
98,676.4 |
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52 Week High |
79.4 |
65.9 |
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52 Week low |
37.3 |
37.6 |
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- Price as % of 52 week high |
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Price Performance (% change) |
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3 months |
-20% |
-10% |
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12 months |
-48% |
-33% |
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Valuation metrics |
COF US EQUITY |
AXP US EQUITY |
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Book value per share |
65.16 |
9.52 |
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Tangible book value per share |
30.74 |
8.05 |
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Earnings per share |
4.02 |
3.42 |
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Revenue per share |
49.02 |
26.90 |
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Price / Sales |
0.95 |
1.92 |
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Price / Earnings |
6.87 |
15.10 |
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Price / Book Value |
0.71 |
5.42 |
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Price / Adjusted Book value |
1.54 |
6.47 |
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Price / FCF |
1.57 |
8.03 |
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Ratios (2007) |
COF US EQUITY |
AXP US EQUITY |
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5 yr EPS growth |
(0.3) |
11.1 |
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5 yr NIM growth |
19.2 |
1.1 |
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NIM Margin |
5.3 |
5.4 |
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Efficency ratio |
54.4 |
65.6 |
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Net Revenue Margin |
76.2 |
87.9 |
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Operating Margin |
20.9 |
17.8 |
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Pre tax margin |
20.2 |
17.6 |
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Provision for loan loss to Total Loans |
2.7 |
7.8 |
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Reserve for loan loss to Total Loans |
2.9 |
3.4 |
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Net Charge off to Average Loans |
2.0 |
4.0 |
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Net Interest Income to Earnings Assets |
3.2 |
(0.5) |
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Interest Income to Average Loans |
10.2 |
14.9 |
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Interest expense to Total Deposits |
5.4 |
27.9 |
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Earnings assets to Interest bearing liabilities |
101.3 |
80.5 |
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Return on assets |
1.0 |
2.9 |
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Return on common equity |
6.3 |
37.3 |
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Total debt to common equity |
153.5 |
662.3 |
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Total debt to Assets |
24.8 |
48.8 |
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Total loans to total assets |
67.6 |
36.9 |
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Total loans to total capital |
165.3 |
65.8 |
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Leverage (x) |
6.2 |
13.6 |
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Interest income |
10,127 |
7,416 |
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Net Interest income |
6,530 |
3,590 |
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Provision for loan loss |
2,637 |
3,901 |
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Interest expenses |
4,548 |
3,826 |
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Non interest expenses |
7,940 |
18,198 |
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Earnings assets |
121,903 |
71,176 |
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Total Shareholder's equity |
24,294 |
11,029 |
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Total Assets |
150,590 |
149,830 |
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Reserve for loan losses |
2,963 |
1,876 |
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Net Income |
1,570 |
4,012 |
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Non performing assets |
936 |
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