Ally Financial Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Ally Financial Inc. is a leading digital financial-services provider, offering a diverse range of automotive, mortgage, and insurance products and services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Ally Financial’s business revolves around providing financing for automotive purchases and insurance products, which are primarily generated through its relationships with auto dealerships, as well as offering direct-to-consumer banking products.

Business Overview:

  • Revenue Distribution: ALLY generates revenue through a diversified mix of operations:
    • Automotive Finance: The largest segment, involving loans and leases for new and used vehicles, dealer financing, and commercial lending for auto dealerships. This segment is largely dependent on auto sales volumes and interest rates.
    • Insurance: Includes a range of insurance products (e.g., vehicle service contracts and GAP insurance) sold primarily through auto dealerships, and, to a lesser extent, directly to consumers.
    • Mortgage Finance: Involves a small mortgage loan portfolio. This segment is a non-core business and accounts for a small fraction of the company’s overall earnings.
    • Corporate Finance and Other: Encompasses commercial financing and other corporate activities.
  • Industry Trends:
    • Automotive: The auto industry is cyclical, driven by economic conditions and consumer confidence. Recent interest rate hikes, concerns about inflation and a possible recession, along with the volatility of used car pricing and increasing financing rates, have put pressures on the demand for auto loans. The shift to electric vehicles is also an important trend and challenge for traditional auto finance companies.
    • Insurance: The insurance market is competitive, with pricing pressures and challenges related to risk management. However, there is a growing demand for ancillary insurance products that protect buyers of both new and used cars, which provides an additional source of revenue.
    • Financial Services: The financial services industry is undergoing significant digital disruption, with fintech companies emerging as serious threats for traditional banks and financial companies.
  • Competitive Landscape:
    • Automotive Finance: The auto finance industry is highly competitive, with captive finance arms of auto manufacturers, regional banks, credit unions, and online lenders all vying for a share of the market. Players include Ally, CarMax, Capital One, and local and regional banks.
    • Insurance: This sector has a fragmented landscape, with both large national players and regional carriers and agents.
    • Financial Services: The financial services industry is one of the most competitive and disrupted industries in the world with lots of competition from traditional banking names and upstart fintech startups.
  • What Makes Ally Different?

Ally’s moat isn’t rooted in having the best technology or the lowest-cost business, but instead lies in its long-standing relationship with auto dealerships, the scale of its existing operations, and to a limited extent its brand recognition within that industry.

*   **Legacy in Automotive:** Ally has a long history in the auto finance sector, giving it a deeply rooted dealership network. This network gives access to a high-volume, lower-cost distribution channel for loan origination and insurance product sales.
*   **Scale and Experience:** Ally's massive portfolio of auto loans and leases enables it to achieve economies of scale and gives it deep expertise in the industry.
*   **Digital Platform:** Ally operates through a digital platform, which gives it lower operating expenses compared to traditional financial institutions, allowing it to price its products attractively.
*   **Customer Service:** Ally has focused on improving customer experience, through digital interfaces and through training of its staff to ensure smooth transactions.
*   **No Branch Network:** As it doesn't have to invest in a costly branch network, it has lower overhead.

Financials:

  • In-Depth Analysis of Financial Statements (latest 10Q - September 2024):
    • Revenue Trends: Net financing revenue and other interest income is the largest contributor to revenue, although it is down compared to last year. Net revenues from finance leases and other interest revenues are up compared to last year. Noninterest revenue is volatile, depending on the mark-to-market changes on investments, and therefore should not be a big concern.
    • Net Income: Net income for the first nine months of 2024 is $1,028 million which is significantly lower than last year’s $3,406 million. A big reason for the significant decrease is the rise in expenses.
    • Profitability Margins: Operating profit decreased as a percentage of revenues year-over-year. Noninterest expenses increased significantly due to one-time writeoffs that were associated with the discontinuance of the business segment. Management is taking action to control costs, which is a positive sign.
    • Balance Sheet: Ally has cash of $42.5 billion and total assets of $192.9 billion, liabilities are $176.7 billion and shareholder equity at $16.2 billion. Total interest-bearing liabilities (excluding nonrecourse debt) were $122.5 billion. The current liquidity is strong, as its cash pile exceeds its total non-operating assets. Its capital position remains solid.
  • Concerns from the Last Earnings Calls and Reports (Q3, Q2, and Q1, 2024):

Management has highlighted the following concerns in its latest earning calls: * Impact of higher interest rates on auto sales and loan defaults. * Continued softness in mortgage segment and reduction in their mortgage business. * Macroeconomic and geopolitical uncertainty. * Increased scrutiny on consumer finance companies. * Increased credit losses * Inflation and its negative impacts on operations

Despite these pressures, Management has reiterated several key objectives: focusing on long term returns and increasing shareholder value, focusing on digital innovation and automation, increasing market share, cost-cutting, and maintaining strong relationships with dealers.

  • Controversies and Problems:
    • ALLY has recently faced headwinds due to increased credit losses and interest rates.
    • The discontinuation of their point of sale (POS) product has also lead to significant writeoffs, pressuring profits.
    • A general market concern about higher scrutiny on financial institutions is weighing heavily on the stock and putting a “ceiling” on the price.
    • Management has indicated that they will be able to meet their targeted 8% return on tangible equity by the end of 2024, which would imply a large improvement in earnings over the next few quarters.
    • The company is also aggressively addressing the issue of rising provisions through risk management strategies and cost cutting initiatives.

Moat Rating: 2/5

  • Justification:

    • Ally’s competitive advantage isn’t particularly strong and is rooted in relationships, scale, and brand recognition in a relatively commoditized market.
    • The company’s extensive dealership network provides a cost advantage compared to new entrants who would have to create their own distribution channels. However, this moat is under threat from the emergence of online-first lenders.
    • While its past profitability has been impressive, there is a serious doubt if that can be maintained given the changing market conditions and uncertainty about future regulation.
  • Risks:
    • Interest Rate Risk: Ally’s business is extremely sensitive to changes in interest rates. Rising interest rates reduce demand for auto loans and increases interest expenses.
    • Credit Risk: An increase in default rates could lead to significant losses on its loan portfolio, especially if it has lent aggressively to subprime borrowers.
    • Regulatory Risk: Increased regulation on the financial industry could place a further burden and more compliance costs on Ally, reducing its profitability and competitiveness.
    • Technological Disruption: Fintech companies that leverage data analytics and artificial intelligence may eventually disintermediate legacy players in auto lending.
    • Competitive Pressures: Other financial institutions or new lenders with lower costs and more innovative business strategies may take away market share.
  • Business Resilience: While Ally has the potential to generate earnings in good times, its financial position is quite vulnerable to credit defaults and a possible recession. Though management has addressed some of these risks, a major economic downturn may have a huge impact on its balance sheet and thus lead to lower value and profitability.

Understandability: 2/5

  • Justification: While the core business of lending and financing is easy to understand, the nuances of the auto lending industry and related finance and insurance products are complicated. The interplay between macroeconomic conditions, interest rate movements, and complex accounting standards makes understanding it difficult. Additionally, the complexity of derivative instruments and financial engineering increases that lack of transparency, making a true understanding difficult.

Balance Sheet Health: 3/5

  • Justification: Current cash position is strong, but there are very large liabilities relative to equity. The debt-to-equity ratio is high. However, it has a proven strategy and processes to manage credit and interest rate risks over long periods. While the recent downturn has shown signs of increased stress, management has taken sufficient measures to ensure a stable enough financial position.