Ally – A Friend for Your Portfolio?
And the Money Center Banks
In the first half of 2022, Berkshire Hathaway purchased a 10% stake in Ally Financial at a price about 40% above today’s price. If you can buy something cheaper than Buffett, it seems worth a look.
Ally is a bank with over half its loan book in auto loans. Ally was spun out of GM in 2014 and used to be GM’s captive finance unit. It’s now the 2nd largest auto lender in America.
Here’s why I think Ally is a compelling investment –
1. Net income has been mostly growing steadily since 2014 and has averaged $1B per year over the last nine years. It has averaged $1.7B over the last 5 years. The market cap for Ally is ~$10B, so it trades at 9x my ‘normalized’ net income, which I assume will be $1.1B going forward.
2. Deposits have grown 56% in the last 5 years, so the $1.1B in net income is conservative. $1.5B is a more likely steady state.
3. Ally has bought back 32% of all outstanding shares over the last 5 years.
4. I think the stock is trading cheaply because management has telegraphed that net income in 2023 will drop to $1.1B from $1.6B in 2022. This is primarily due to higher expected losses on the portfolio.
5. Delinquencies on the auto loan portfolio are at a 4 year high. While this is not great, Ally has $3B in loss reserves on about $95B in loans. Given auto loan delinquency rates peaked at about 4.5% in 2009 this seems adequate. They’re essentially covered for 4% in losses (I don’t think this recession will be as deep as the financial crises) for the next 1.5 years at a 50% recovery rate.
Given Ally has essentially been in business for 100 years, it seems cheap at 9x normalized earnings. Granted things could get worse in the short term, but if you have a holding period of at least three years, this should return 50% or better.
There are of course many risks -
1. Bank’s financial statements are complicated and I’m no expert at analyzing them. It’s possible that I’m underestimating losses given I can’t analyze their loan book. Ally is forecasting net charge offs of 1.7% in 2023 vs 1% in 2022, and in the math above I use 2% for 2023 and 1% for 2024. I have no way to assessing the quality of the underwriting of loans they originated from Q3 21 to Q2 22 and these loans make up 38% of the portfolio and are about to enter their peak loss timing. Its possible losses are meaningfully higher because car prices fall further than in any time in history because they also inflated so much in 2021.
2. The deposit base shrinks, so they need to issue debt to finance their balance sheet, which results in NIM (and therefore earnings) shrinking. So far there are no signs of this being an issue.
3. Competition intensifies. The bulk of Ally’s loans are to GM and Stellantis buyers. Stellantis recently announced plans to spin up their own captive finance arm, so Ally could see a decrease in loans it can originate.
4. Losses in the insurance business. Ally has an insurance operation, which while small ($300m in earned premiums in Q4 2022), could result in significant losses going forward if their underwriting standards are weak (which is hard for me to assess).
5. Dumb acquisitions. In the heady days of late 2021 Ally paid $750m in cash for a credit card company with $816 in loans. Based on multiples for large credit card firms, it seems like they overpaid by 3x. Hopefully, the current tight environment prevents such future stupidity.
There are also some positives -
1. The CEO has been in place since 2015 and done a decent job growing the business and using excess profits to buy back shares.
2. The smartest bank investor in the world (Buffett) is now a shareholder, so hopefully the CEO will consult with him on capital allocation in the way that Tim Cook at Apple has.
Here’s a spreadsheet, with some numbers for Ally as well as the big money center banks.
On a separate note, I think Bank of America, Wells Fargo and Citi also represent good value here. BofA and Wells are trading at 12x my normalized earnings. Citi is trading at 8x. You can put in your best guess for normalized earnings in the spreadsheet. I don’t see these banks going anywhere for the next 20 years, so these multiples seem cheap. I get these are cyclical businesses, so maybe the multiples never go up, but the downside seems minimal at these levels. The fact that Goldman lost $3B in their attempt to start up a consumer deposit franchise shows how hard this business is. The reality is that checking and savings accounts are sticky. People have automatic bill pay set up and most folks with $30k across their checking and savings accounts don’t care about making an extra 2% on their cash in the bank. If they decide they do care, Ally will continue to grow 😊. These three money center banks have all bought back ~25% of their stock in the last five years, so even if they don’t grow revenue, but are able to continue buy backs at a similar cadence, the risk / reward seems compelling here.
I’d love to hear your thoughts. Email me at investmentfodder@gmail.com.