Synchrony Financial

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Synchrony Financial is a consumer financial services company, offering a variety of credit products, credit cards, commercial credit products and consumer installment loans. It is among the largest providers of private label credit cards in the United States.

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.

Business Overview: Synchrony Financial operates as a consumer financial services company, distinct in its focus on private label credit cards and installment loans. Unlike typical banks, Synchrony primarily partners with retailers and merchants to offer branded credit cards, often with promotional financing options. These partnerships are fundamental to their operations, providing a unique acquisition strategy and a customer base that is often loyal to the partner retailer and therefore to Synchrony itself. The company’s revenue streams from interest on loans, retailer share arrangements, payment processing fees, and fees associated with additional services. In 2023, Synchony earned around $16.8 billion in net interest income. This was down slightly from last year which indicates a difficult macroeconomic environment.

  • Sales Platforms: Synchrony operates through 5 main sales platforms: Home & Auto, Digital, Diversified & Value, Health & Wellness, and Lifestyle.
    • Home & Auto: Offers financing for home improvement, furniture, flooring, and automotive industries
    • Digital: Primarily focused on point-of-sale financing for online merchants, including marketplaces like Amazon, and digital payment solutions.
    • Diversified & Value: Offers payments and financing through large retailers including Belk, FootLocker and JC Penney
    • Health & Wellness: Provides financing options for healthcare, dental, and vision, as well as petcare and veterinary expenses.
    • Lifestyle: Focuses on payments in recreational, outdoor, music and luxury industries
  • Competitive Landscape:
    • Synchrony operates in a highly competitive industry, facing competition from traditional banks, credit unions, fintech companies and other credit card issuers. The competitive intensity is especially significant in the areas of balance-transfer offers, point-of-sale financing, and unsecured lending. Competition also arises from other consumer finance providers that offer credit cards to retailers. The nature of the competition has resulted in the companies having to be very innovative with their product offerings and try to offer better services while also being conservative in their financial strategy.
    • The company’s reliance on partnerships for customer acquisition means that the performance of its partners also plays a key role in their performance. Therefore a large diversification of partners is essential for the company.
  • Financial Highlights (as per Q3 2024 results):
    • Net interest income increased 11.6% to $4.5B for the quarter and 9.9% to $13.6B for the 9 months ending 9/30/2024.
    • The loan net charge off rate increased from 3.7% to 4.8% year-over-year. This shows consumers are finding it hard to repay their debts.
    • Net credit losses increased from $1.1 Billion in the nine months ended September 30, 2023, to $1.7 Billion in nine months ended September 30, 2024. This also confirms weakening consumer spending power.
    • Net income increased 5.2% in the three months ended and decreased by 0.3% for nine months ended September 30th due to increased credit expenses.
    • Loan receivables increased 11.4% to $163.2 Billion as of September 30th 2024.
    • Synchrony’s core strength resides in its strategic partnership with retail brands, a diversified customer base, and its ability to leverage digital platforms for customer engagement.
    • However, higher interest rates have put pressure on consumer spending power and are impacting Synchrony’s loan volume as well as the riskiness of their borrowers.

Moat Analysis: Synchrony’s moat is considered Narrow (2/5), based on several factors: * Switching Costs: Synchrony benefits from some degree of customer lock-in, due to the nature of its credit programs being tailored to specific retailers. However, competition from other banks and financial institutions still allows customers the possibility of moving to a different credit program. * Brand Strength and Customer Loyalty: While a strong retail brand may carry value, it is the underlying strength of a credit card that actually builds up long-term customer loyalty. This makes it hard for the company to have a wide moat due to relying more on the strength of their partners rather than their own brand equity. This also makes them vulnerable if their partners underperform. * Economies of Scale: Synchrony benefits from economies of scale in operational efficiencies and data management, which are primarily a result of the large volumes of credit information they process and their ability to analyze that data. However, other big lenders also have the same economies of scale, reducing the power of their moat in this area. * Network Effects: The company has only a limited network effect. As a lending company, having more clients doesn’t create any significant advantage other than economies of scale.

Risks to the Moat and Business Resilience:

  • Macroeconomic Factors: A slowdown in the economy or changes in interest rates could negatively impact consumer spending and lead to increased defaults on loans. This directly puts pressure on Synchrony’s profitability due to its reliance on loan revenue. The current macroeconomic conditions of high interest rates and tight credit lending standards are having a negative impact on the company’s net income in the short-term, which is not expected to improve significantly in the next few years.
    • The CFO stated that in the near term “we expect net interest margin will continue to be lower and net charge off rates will remain elevated”, as well as “modest purchase volume growth”.
    • The company expects these to reverse in the second half of 2025 if the Fed is able to lower interest rates and the economy is able to regain some of its strength.
  • Regulatory Risk: The company is subject to regulations from the Federal Reserve, CFPB and various states. The risk of more unfavorable regulations negatively affecting the business is always present in this sector. New credit regulations being discussed by CFPB also present a risk that the company is actively monitoring and taking steps to reduce the potential impact on their profits.
  • Credit Risk: Synchrony faces the risk of defaults or delinquencies from borrowers, which will lead to losses. The quality of the company’s loan portfolio depends on the underlying creditworthiness of their consumers and their abilities to pay back the debts. This was shown with the latest earnings data which showed a spike in net loan losses. The loss rates may increase if the economic condition continues to worsen for consumers.
  • Competition from Fintech: New fintech companies are creating innovative solutions that offer credit to customers with faster, lower cost and more convenient access. The new technology may give them an advantage over the more traditional banking style that Synchrony follows, which is a serious risk.
    • While they have been innovating in the digital lending space, they may not be able to innovate as fast as more specialized fintech firms that are more focused in this niche.
  • Concentration of Business: A good portion of the business, while diversified across a variety of industries, is still dependent on a few big names like Amazon, Lowe’s, and PayPal. If the partnerships with these major players become disrupted, it could create problems for the company.
  • Management Risk: The success of the company is heavily dependent on leadership and management quality to allocate capital effectively, develop strategies, manage risk and continue to find new partnerships, while also meeting all other operating needs, all of which can be difficult.
  • Cyber Security Risk: Being a financial institution, they are a big target for cyber attacks. A successful hack into the system can lead to loss of data as well as loss of trust and therefore business.
  • Business Resilience: Synchrony has shown a degree of resilience to various market downturns due to the consumer loyalty of its partners’ customers. However, any change in the macroeconomic environment could greatly influence the business negatively.

Financial Analysis:

  • Income Statement: Synchrony has had consistently growing revenues and net income for many years. However, as we have seen earlier, the recent results have been impacted negatively by the high interest rate environment, which directly eats away at their interest margins, as well as putting pressure on consumer lending and causing an increase in loan defaults.
    • Total revenues have gone down slightly and are expected to remain muted in the short term, which shows that the business is facing headwinds, and is at a turning point that could lead to further decline in the short term.
    • Profitability for Synchrony has always been good, consistently in the higher double digits (over 10%) before taxes, but that may not continue as they move through the current macroeconomic environment.
  • Balance Sheet: The company’s balance sheet is reasonably healthy, with the debt-to-equity ratio around 0.30 which suggests the company is not in financial duress. The tangible book value per share is $30, which means the company could technically pay out 29% of its liabilities before going below its cash value. This is a fairly good metric that provides a good buffer for any financial storm.
    • The company has $11 billion in cash and equivalents which, combined with a $2.5 billion undrawn line of credit, means the company has enough liquidity to navigate through volatile economic conditions.
  • Cash Flows: The company’s cash flow has been impacted by the recent increased provisions for loan losses. However, the company is still generating enough cash and free cash flow to support growth. For the three months ending September 30, 2024, the company generated positive cash flows from operations and financing, even with a negative cash flow from investing.
    • The company has continued its share repurchase program to distribute capital to shareholders, despite headwinds from the credit market.

Recent Concerns/Controversies: * CFPB Regulations: A new CFPB rule may have a negative effect on their credit card business as they would have to reduce late fees and other charges to consumers, reducing a significant revenue source. * Management is trying to navigate through these changes without any significant impact on long-term earnings. * Concerns about Future Guidance: Many analysts and investment firms have concerns about the lack of an update regarding the future guidance for the company. Investors want to see more guidance on the future profitability of the business, but management isn’t too forthcoming. * Increased Credit Losses: The company is experiencing higher credit losses, which is impacting their earnings negatively and has led to the company taking higher credit reserves. Investors will look towards the next quarterly reports to see if the situation has improved.

Understandability Rating: 3 / 5

  • The business of Synchrony is reasonably easy to understand at its core: it’s a credit provider. However, it has intricate relationships with retailers, where credit quality is not as simple as a standard bank.
  • There are also several accounting adjustments needed to understand their statements due to a reliance on non-cash based earnings metrics. * Further, understanding the intricacies of its many partner programs and how they generate revenue requires some degree of financial knowledge. Also, the macro economic conditions influencing their business model must also be taken into consideration.
  • Because of the above factors, I give it a moderate understanding score.

Balance Sheet Health Rating: 4 / 5

  • Synchrony has a good financial position as the Debt-to-Equity ratio is relatively low, especially when looking at other consumer financial institutions. The loan portfolio is very large with enough liquidity to sustain themselves. They have a manageable debt and are able to borrow at favorable rates.
  • However, there are some risks for the company due to the current macroeconomic situation, and therefore some weakness can be present that needs to be looked out for in the following reports and this takes away from the higher rating.

In Summary, Synchrony is a business with a narrow moat and has a reasonably healthy balance sheet. However, due to several factors impacting their business, the company may require time to regain some stability and improve its long-term prospects. Any long-term investor would need to analyze the company closely before investing.