Things are working out so far with our Synchrony Financial investment in our ADI portfolio. Let’s take a look at what Synchrony Financial does, why we made the investment, and where we go from here.
It is always important to know what you own. So let’s take a look at what Synchrony Financial does and how it makes money.
Synchrony’s history dates back to 1932 when General Electric founded their General Electric Contracts Corporation to help customers finance appliance purchases. Through the 20th century, this in-house GE financial company expanded to include additional services like a capital division to finance sales for independent appliance and consumer electronic merchants, a plastic credit card, a Lowe’s company credit card, additional companies’ private credit cards, and even a mobile consumer deposit bank.
In 2014 GE partially spun off Synchrony in an IPO, and then by 2015 Synchrony had been fully separated from GE and is now a fully independent company and a member of the S&P 500. The stock ticker is SYF.
So how does Synchrony Financial make money? What does Synchrony Financial do?
Synchrony has three business lines; Retail Card, Payment Solutions and CareCredit.
Retail Card is a leading provider of private label credit cards. They have store cards like the Lowe’s company card where you can only make purchases at Lowe’s. And they have other versions of credit cards like the Sam’s Club card where you can make purchases at Sam’s Club and you can also make purchases anywhere else like a normal credit card (dual cards).
They make money in their retail card division from interest and fees on the loan receivables, as well as interchange fees when the dual cards are used outside the retail partners’ stores.
Payment Solutions is a leading provider of promotional financing for major consumer purchases, offering private label credit cards and installment loans. An example of this kind of business is if I went to buy a refrigerator at Lowe’s and Lowe’s offered me a 12 month interest free loan to buy the refrigerator. Synchrony would be the provider of that loan and they’d make interest (potentially) and fee income from me.
And CareCredit is a leading provider of promotional financing to consumers for health and personal care procedures, products or services. And example of CareCredit would be if I went to get a cosmetic dental procedure and CareCredit would offer me a 12 month loan on the procedure’s cost.
You can read about Synchrony’s three business lines, starting on page 7 of their 2017 annual report.
The credit card business makes up about 75% of their business. This is from the 2017 annual report.
They had 29 retail credit card partners (stores they run company credit cards with) in 2017, and I think they’ve grown that number since.
I think there are only 5 or 6 major competitors in this private label card credit card space.
They work with some of the biggest retailers in the US and have long relationships with them. From a 2018 presentation:
So where does Synchrony get all the money to lend out to their partners’ customers when they make credit card purchases and request loans to purchase large items? Here’s the beautiful thing about Synchrony. They’re also an online bank! And almost 75% of their funding comes from relatively low cost deposits.
Synchrony pays a higher than normal savings yield (above 2% as a write this) and a higher than normal CD yield (the one year is 2.8% as I write this). And they also have some debt funding. From a 2018 presentation:
I don’t know the exact numbers, but as I understand it, the business model is a standard bank or credit card model. Have a funding base of mostly customer deposits and some debt, lend out the funds via loans and credit cards to customers with good credit profiles, and make a higher return from that lending activity than the cost of the funds.
I like that they only have a few competitors, and there does seem to be some kind of moat around running a private label credit card company. If another bank wanted to come in and be Lowe’s credit card provider, how does that happen? Knowledge of the products, knowledge of the customers, knowing who is a good credit risk, the physical and digital equipment that makes everything run. I don’t know how big a deal it is to change credit card partners if you are one of these big retailers, but it seems like a big deal.
I will listen to the market here and let the data show me that the moat is substantial. The first point of evidence here is the small number of private label credit card company competitors. Again, I think there are only 5 or 6 other companies in this business. And the second data point of evidence is the long term length of their relationships with the retailers and the renewing of those relationships that they report.
It’s a strong business, and I love how it is a win-win-win situation for everyone involved. Online bank customers, the funders, get above average savings and CD yields. Retail partners’ sales increase because customers have access to credit, and they offer a better customer experience because they can offer promotional deals. Customers also benefit from great credit card rewards, for example the Sam’s Club card pays 5% cash back on gas and 3% cash back on restaurants, while the Lowe’s and Amazon cards pay 5% back on their respective store purchases. And finally, Synchrony and its shareholders win because the company makes a profit on the cost of the funds (mostly deposits and some debt) and the fee and interest revenue on the credit card balances and loan receivables. And they return a lot of that income to shareholders via share buybacks and dividends.
Is it too good to be true? Who is funding all this? Well, I don’t know how big a factor interchange fees are, but that is where some of the profit comes from. And you would think the rest comes from high interest rates when people don’t pay their credit card bills on time, or high interest rates on loans. However, you could argue that in a capitalist system these customers are still winning because they get access to appliances and other products and services they wouldn’t get without the purchasing power Synchrony gives them. And if they want to pay high interest rates for a short amount of time to get that purchasing power, then they decided that it was worth it. Is that sustainable? It seems to be. Credit card companies have been in business for a long time.
To summarize the business, Synchrony Financial is a credit card and loan company that partners with retailers to offer store credit cards, dual-use credit cards, and promotional loans. They also have a CareCredit line of business where they offer loans to medical patients. The credit card business is their primary business, making up about 75% of their revenue. They work with some of the biggest retailers in the country and have long-term relationships with them.
The funding for the credit card and loan business comes from customer deposits, as they are an online bank, and also debt. Customer deposits make up close to 75% of their funding.
Now that we’ve covered Synchrony Financial as a business, let’s talk about why I made the investment and the performance so far.
As Mohnish states in the 10 commandments of investment management, thou shall be a shameless cloner, and a shameless cloner I am. I first came across Synchrony Financial when I saw that Berkshire Hathaway purchased Synchrony in the second quarter of 2017 (13F on Whale Wisdom). Given the $500 million investment size, I figured it was a Ted or Todd investment.
During that second quarter of 2017, Synchrony dropped from $33 to $26. When Berkshire’s 13F came out I studied Synchrony, felt I understood the business, liked the low PE it was selling for, and thought if it was good enough for Ted or Todd, it was good enough for me. And I bought in at $34. This was a personal purchase before I started the After Dinner Investor portfolio, and I continue to hold these Synchrony shares and enjoy the dividends.
A lot has happened since then.
In the summer of 2018 Synchrony reported that one of their biggest clients, Wal-Mart, was ending their 19-year relationship and moving to Capital One. And then in November Wal-Mart sued Synchrony for $800 million alleging that Synchrony’s underwriting standards had harmed Wal-Mart.
Bad news, and more bad news. And you can see how the stock price declined from $35 to the low $20s, and this was also while the overall market was in decline in December.
And here is where we got lucky with our timing. I launched the portfolio in late November, and on December 4th I purchased a stake in Synchrony at a price of $25.35. And as I write this, Synchrony is at $32 and we’re up 28% in three months.
And a lot of good news has helped rise Synchrony’s stock price since I purchased. The overall market is back up into the new year, Wal-Mart dropped its lawsuit, and Synchrony extended its partnerships with Sam’s Club and Amazon. There was a concern that Synchrony would lose the Sam’s Club relationship since Sam’s Club is part of Wal-Mart, so seeing that extension was a sign of relief.
Buy, Sell, or Hold
And that’s where we are today. Up nearly 30%, and Synchrony is currently around 6% of our portfolio.
Right now I plan to just hold. Berkshire bough more Synchrony in the third quarter of 2017, but since then they haven’t bought anymore and haven’t sold any.
I like that Berkshire continues to hold Synchrony, and I plan on doing the same.
The trailing PE is 8, the forward PE is 7, the dividend is 2.6%, the payout ratio is 19%, earnings are expected to grow, share count is expected to shrink, and dividends are expected to grow as well.
I love how much of their business is funded by customer deposits, as opposed to debt, and I also really like the win-win-win nature of their business model that I described above.
I don’t see any reasons why the company shouldn’t continue to do well, and going forward over the coming few years it looks like we could possibly have a nice situation of not only earnings per share growth, but also PE multiple growth as well.
You can see in their 2018 fourth quarter earnings presentation that they’re continuing to grow, renewing partnerships, and adding on new partnerships. And they’ve been buying back shares at a low multiple. On page 6 in their 2018 fourth quarter earnings press release, you can see how their 2017 share count was 770.5 million versus an end of year 2018 share count of 718.8 million.
Why should such a strong company sell for a multiple of 6 to 8? I don’t get that. It looks like there’s a very good chance that earnings will continue to grow, earnings per share will continue to grow, and if those things happen, the PE multiple could rise as well, giving Synchrony an even bigger price appreciation.
For the time being, I plan to enjoy the dividends, focus on the Synchrony’s business results, and as long as those business results are good, hold on and see what happens with the earnings and the PE multiple.
But as always, it’s good to ask, what could go wrong? A lot could go wrong. A recession and weakened earnings, a loss of retail partnerships, and bad underwriting and an increase in loan losses. But bad business results do not seem very likely given the long history of the company and their recent strong business results, and I’m not in the macro economic prediction game and can’t predict recessions.
Given the strong business results, the low PE multiple, the win-win-win aspect of their business (I’m a happy card customer myself), and the fact that we’re cloning Ted or Todd, I feel comfortable with Synchrony being 5% to 15% of my portfolio.