One of the interesting things to observe in the economy during the late upward stages of an economic cycle is consumer lending. A struggling economy usually prompts the Federal Reserve to lower interest rates in an effort to encourage more business activity. Lower interest rates mean cheaper borrowing for businesses and individuals. For the purposes of today’s spotlight, I want to focus on the consumer side of that dynamic.
When interest rates are lower, mortgages are more affordable, and so is just about every kind of credit that you or I as consumers have access to. Car loans, major credit cards, and even department store credit accounts all start to become more attractive. Perhaps the irony of this fact is that when rates are lowest, and all of these credit instruments are the most affordable, it usually means that the economy has been contracting. The Fed lowers interest rates to encourage more borrowing, and so to spur more economic activity.
At the late stage of an economic expansion, interest rates rise as the economy heats up. Part of this comes from the ease and availability of borrowing that was facilitated by lower interest rates; as demand for credit products picks up, interest rates eventually start to increase as well just as a stock that is experiencing more buying activity will usually start to see its price rally higher. Rates also start to increase at this late stage because the Fed begins raising the rates it charges to banks and lending institutions (called the Fed Funds rate) in response to signs that the economy’s growth could be starting to move more quickly that it should.
What does all of this mean for consumer lenders? It usually means that when interest rates are increasing, they’re doing pretty well, because more and more consumers are taking out loans to pay for a variety of the goods they work with. Of course, that is something of a ticking clock, because when the economy does finally start to reverse, things aren’t so great for consumers. Unemployment usually starts to increase, which also means that personal income usually drops as well.
The ironic thing about everything I just outlined is that lately, the story seems to have been turned a bit on its head. Most U.S. economic indicators show the U.S. economy is still growing, but in July the Fed cut interest rates by a quarter point in what they termed a “preventive” move due to pressures that include trade tensions from tariffs as well as a slowing global economy. To add intrigue and drama to the situation, President Trump is agitating for steeper rate cuts, using his active Twitter account to lash out at the Fed in general and Fed President Jay Powell in particular.
Until July, the Financial sector had been among the strongest performers in the stock market, surging a little over 30% from the beginning of the year. Over the last month, however, the sector has lost a lot of steam, which seems to imply the Fed’s rate cut had the opposite effective on investor fears, at least in the near term, as it simply increased speculation about whether the economy in the U.S. is as healthy as most think. The reemergence last week of an inversion of the 2 year Treasury note yield versus the 10 year bond – the second time it has happened this year – has added to concern recessionary conditions may be closer than most think.
Economic concerns such as what I’ve just outlined are among the reasons Ally Financial (ALLY) has pulled back along with the entire Financial sector. Despite dropping almost -11% in the last month, the stock is still up nearly 33% year to date. Both moves could be interpreted as positives for bullish investors – the longer trend is up, and the stock has pulled back from a recent high, suggesting there could an opportunity to “buy the dip.” Formerly known as General Motors Acceptance Corp (GMAC), ALLY re-branded itself in 2010 as part of a transformation and rebirth following the financial crisis of 2008 as a consumer lender. Historically known for auto financing, which remains its largest source of revenue, the company has also branched into mortgage lending, insurance, and online banking. They launched their own initial public offering in 2014 and have expanded their scope even more to start including credit card lending and even wealth management (stock and option brokerage) services. They have a lot of fundamental elements working strongly in their favor; but does that make them a good buy right now? Let’s dive in and take a look.
Fundamental and Value Profile
Ally Financial Inc. is a digital financial services company. The Company is a bank and financial holding company. Its segments include Automotive Finance operations, Insurance operations, Mortgage Finance operations, Corporate Finance operations, and Corporate and Other. The Automotive Finance operations segment provides the United States-based automotive financing services to consumers and automotive dealers, and automotive and equipment financing services to companies and municipalities. The Insurance operations segment offers both consumer finance protection and insurance products sold through the automotive dealer channel, and commercial insurance products sold directly to dealers. The Mortgage Finance operations segment consists of the management of a held-for-investment consumer mortgage finance loan portfolio. The Corporate Finance operations segment provides senior secured leveraged cash flow and asset-based loans to mostly the United States-based middle market companies. ALLY’s current market cap is $10.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by almost 17%, while revenues rose about 6.5%. In the last quarter, earnings increased a little more than 21%, while sales declined by about -3%. The company operates with a very healthy margin profile, with Net Income running at 26.5% of Revenues for the last twelve months, but decreasing in the last quarter to a little over 20%.
Free Cash Flow: ALLY’s free cash flow is very healthy, at $3.9 billion. That translates to an outsized Free Cash Flow Yield of about 34%.
Debt to Equity: ALLY’s debt/equity ratio is 2.62, which is a high number but is pretty normal for any consumer lending company. In the last quarter, ALLY’s cash and liquid assets were about $3.5 billion while long-term debt was more than $37.4 billion; however, their strong margin profile does indicate that they can service their debt without any problems.
Dividend: ALLY pays an annual dividend of $.68 per share, which translates to a dividend yield of about 2.26% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value. ALLY’s Book Value is $36.67, which means that the stock’s Price/Book ratio right now is .82. I usually sit up and take notice when I find a stock with a Price/Book ratio below 1, and seeing one that is nearly 20% below its Book Value under normal circumstances is usually a very good thing; however in ALLY’s case, that positive number is leavened by the reality that since becoming its own publicly traded company, their historical average Price/Book ratio is .76, which means that the stock is somewhat overvalued. ALLY would have to drop down to around the $22 level before I would consider there to be a useful valuation argument for this stock.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line traces the stock’s upward trend from the beginning of the year to its peak above $34 in July; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s pullback from that high has put it within about $1 of the support line shown by the 38.2% Fibonacci retracement line, which could provide a level for the stock to consolidate and turn back to the upside. Technically speaking, that is the more likely scenario, given the strength of the stock’s upward trend over the course of the year. If the stock does form a pivot low anywhere between $29 and $30, with a push above $31 to confirm the short-term reversal, the stock should retest its all-time high around $34 per share. If the stock drops below $29, however, its next mostly support will be around $26, where the 61.8% retracement line rests. If the stock turns bearish enough to drop to those levels, a test of the 88.6% retracement line around $22 isn’t out of the question. That might sound unlikely given the strength of the upward trend, but if some of the economic fears and pressures related to trade that have pushed the stock lower in the past month continue or are proven correct, it wouldn’t be that surprising.
Near-term Keys: If the stock breaks above the recent resistance we’ve see around $31, you could consider placing a short-term bullish trade by buying the stock itself or using call options, with a target price around $34. A drop below $29, however, could act as an interesting signal to think about shorting the stock or working with put options, with a near-term target price to exit a bearish trade at around $26 per share. The stock has some interesting fundamentals working in its favor, but I think current conditions and market uncertainty are unlikely to yield a lot of upside for the stock right now, so I don’t think there is any practical way to think of ALLY as a useful value play right now. The stock would really need to drop to around $22 before a realistic argument could be made for ALLY on that basis.