A Big Win for Synchrony and Square's Ecosystem That Gets a Little Stronger

Check out the latest Synchrony Financial and Square earnings call transcripts.

Synchrony Financial (SYF +0.01%) just got a big win, with two lingering issues resolved in the bank's favor. And Square (SQ +0.02%) recently rolled out yet another new product designed to strengthen its ecosystem even more. On this week's episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP, give listeners the must-know details about these stories, answer some great listener emails, recap big bank earnings, and more.

A full transcript follows the video.

This video was recorded on Jan. 28, 2019.

Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Monday, January 28th, which means we're talking Financials. I'm your host, Jason Moser. Joining me in the studio via Skype, as usual, we're always happy to have him here, Certified Financial Planner, Matt Frankel. Matt, how's it going?

Matt Frankel: Pretty good. It's been an interesting Monday.

Moser: [laughs] Yeah. Care to share just a little bit of that with our listeners? I don't want to overstep my bounds here, but as a parent, I was feeling for you.

Frankel: [laughs] Well, my three-year-old daughter at her preschool class, she tripped over the stool for the toilet and wound up whacking her head on it. Whenever that happens, whenever it's a head injury, they have to have a parent come in and take a look. So, we're recording this a little bit later than usual, but she's totally fine. She was running around giggling. Other than a little bit of a goose egg on her forehead, you wouldn't even know anything happened.

Moser: Yeah, I've gone through that once or five times with my kids growing up. I appreciate that they have that policy. It doesn't make it any easier. Big shout-out to Austin for being so flexible to change his schedule, as well, so we're able to get you guys the show.

Speaking of the show, we've got a big one today. We're going to talk about the latest in the developments with Synchrony and Walmart (WMT +0.00%). It looks like Square has a new business debit card. We've got a listener email to get to. We'll tap into Twitter. We'll give you One to Watch.

We're going to begin the week with the winners and losers so far this earnings season with the big banks. Matt, we'd talked about a lot of these big banks a couple of weeks ago. We were looking at some of the opportunities and the challenges in the quarter they're reporting. You've gone through these releases, you've seen some of the winners, you've seen some of the losers. Tell our listeners what you found.

Frankel: For the most part, there weren't too many big surprises. Banks, as a rule, are a generally predictable industry, especially commercial banks. Having said that, there were a couple that stood out. Bank of America (BAC +0.00%) was, I think, the best out of the big four banks. They just keep improving and keep getting better and better. They're really doing a good job of putting their pre-financial crisis self well in the rearview mirror. If I'd told you in, say, 2010, 2011, that Bank of America was going to be probably the best-looking out of the big four banks, you would have told me I was crazy.

Moser: I know I would have. Just a year ago, it seemed like Brian Moynihan and Bank of America were stepping in something new on a daily basis. Now, it seems like they've passed that torch on to Wells Fargo, huh?

Frankel: Right. And a few years ago, if I had told you that anyone but Wells Fargo was the best-run bank out of the big four, you would have called me crazy. Times have certainly changed in that regard.

The biggest surprise in my mind to earnings were the two big investment banks, which are generally less easy to predict. So, if there's a surprise, a lot of times that's where you're going to find it. Goldman Sachs (GS +0.00%) had a blowout quarter. Goldman had been one of the worst-performing bank stocks because of the drama related to the Malaysia bond fund gone bad. That's still definitely an overhang on the stock, which is why it's trading for significantly less than book value. But the bank, its earnings were excellent. Lending and investing revenue, which includes the Marcus division, was up by 56% year over year.

That's huge, and Marcus is still a very small component of the business. They just announced recently at the Money20/20 conference I was at that they're expanding into wealth management. They've already expanded into personal loans and savings products for Main Street, so now this will bring even more people into their ecosystem. Historically, Goldman's been a wealth manager for the 0.01%, so this is really opening new doors for them. It's been successful so far, plain and simple. They made their first personal loan, just for example, in October 2016. Two years later, they hit $4 billion in personal loans, which is a drop in the bucket in terms of a big bank but is quicker than Lending Club even got to that level. It's impressive growth so far, and tons more room to grow.

CEO David Solomon at a recent presentation said that possible avenues include mortgages, auto loans, insurance products, checking accounts offered online that pay nice interest rates. There's a ton of room to expand this. I've said it before, but I don't think the market appreciates what a big force in commercial banking Goldman Sachs could become. It's got a phenomenal brand name and it doesn't have any of that legacy infrastructure that weighs on profits that any of the other big banks have. It doesn't have branches or anything like that. It has this great opportunity to grow, and it's really been reflected in their earnings.

On the other side of the aisle, Morgan Stanley (MS +0.01%), their fourth quarter was a big disappointment. It was a standout, one, because bank earnings generally were good. Everyone pretty much beat earnings estimates, beat revenue estimates. Morgan Stanley did not. They missed on both the top and bottom line. Trading revenue was particularly weak. Morgan Stanley's fixed income trading was down 30%. I think Goldman's and a few of the others' were down 18%. So, while trading revenue was pretty weak across the board, it was weaker than peers, which is always a bad sign. If a certain metric is generally terrible and equally terrible, it's not necessarily a bad sign for a company; but when you're underperforming your peers, that's when you want to watch out. That's what happened with Morgan Stanley. Wealth management business missed expectations, as well.

All in all, it just was not a great quarter. When you miss on the top and bottom lines, there's usually a reason for it. There was, it's their trading. Like I said, that's the most unpredictable part of banking, in my opinion, is trading revenue. Don't read too much into one quarter's trading revenue. But all in all, Morgan Stanley was the disappointment, and Goldman Sachs was the winner. Over the past couple of weeks since earnings, you've seen a lot of price divergence between the two.

Moser: Sure. Really quick, going back to Goldman Sachs for a second, it made me think of something I'd like to get your opinion on. Do you feel like Goldman Sachs, given the move to open up their lending to a bigger audience, pursuing Main Street, given Goldman Sachs' reputation, the brand, the aspirational, maybe, nature of that brand from your everyday Main Streeter, do you think there's a parallel with what they're doing with what American Express had to do a little while back in opening their product suite up to more customers, taking that brand that they've had, that they've done so well over so long nurturing, a bit of an aspirational brand, opening that up to more clients with more products? Do you feel like Goldman Sachs benefits from that kind of boost at all?

Frankel: Sure. That's actually a great comparison!

Moser: Why, thank you!

Frankel: For those who aren't familiar, American Express was a credit card for rich people up until a decade ago or something.

Moser: Exactly! I feel like most people on Main Street probably feel like, "Oh, forget about Goldman Sachs, that's just for rich people." But apparently, not so anymore, right?

Frankel: Right. And now, anybody with $20 can walk into a Walmart and get a prepaid Amex card. That's the extreme end of their product line, but they've become a credit card company for Main Street. They still have their high-end products. And in my opinion, they're the best in the business at high-end credit cards. The Amex Platinum is, in my opinion, the best credit card product on the market. It's in my wallet right now. But, they've done a great job of opening their business up. It's leveraging their brand name.

Goldman Sachs actually has, in my mind, a unique advantage over peers. Not just the brand name. Bank of America, Wells Fargo, these are all good brand names, too. But, they all have this big legacy branch infrastructure overhanging their heads. Pretty much all of them are reducing their branch count over the past few years and continue to do so because it's really eating into their costs and eating into their ability to be competitive. If you see Goldman Sachs right now, their Marcus savings account pays 2.25%. Bank of America and Wells Fargo pay about 0.1%. And the reason that they can afford to do that is because they're not paying all these costs associated with branches. Not just the physical buildings, but paper costs, employment costs. There's a ton of costs involved in opening a branch, and Goldman doesn't have to worry about any of that. That, I think, is going to be even more of a competitive advantage than its brand name.

Moser: Earnings season is just getting underway. I'm sure we have more banks coming, but it's definitely been an interesting few weeks thus far.

Let's take a look at this. Back in November, Matt, we took a listener question from @BTCapital12 on Twitter. There was a situation brewing with Synchrony and Walmart and litigation that the massive retailer was threatening. Matt, I'll let you take a little bit of a victory lap here. I'm going to go ahead and hand it to you. Explain away.

Frankel: Thank you for giving me my I-told-you-so moment. [laughs] In the middle of last year, over the summer, Walmart announced they were dropping Synchrony as their co-branding partner. Big account. I liken this to, using another Amex comparison, when Amex lost Costco. It's to that magnitude. It's a big deal to them. But the real drama came a little bit later.

One, as everyone knows, Walmart and Sam's Club are the same company, but they're two different credit card products, in terms of Synchrony's line of products. There was a big question mark as to what this meant for their Sam's Club business, which is also a huge part of Synchrony's business. Do they keep that? Does that go to Capital One, where Walmart's going? Two, Walmart announced that they were suing Synchrony for $800 million related to losses on their credit card portfolio. They said Synchrony didn't do a good job of analyzing credit risk, and there were bigger losses than expected, and they weren't making as much money as a result. That was a big question overhanging.

I forget my exact words, but I said that it was somewhat of a negotiation tactic, because Synchrony had to decide whether it wanted to keep the Walmart loan portfolio, sell it to Capital One or somebody else. There were a few things that needed to happen before the relationship could be completely dissolved.

Just recently -- this was also a big surprise of earnings season -- not only did Synchrony have a great quarter, but they pretty much said the two things investors really, really wanted to hear: that they're keeping the Sam's Club business, the Sam's Club credit card will remain a Synchrony product. That's a big deal. And, even bigger, Walmart is completely dropping its lawsuit against Synchrony. An $800 million weight off their shoulders is a very nice late Christmas present for Synchrony investors.

The markets hate uncertainty. Uncertainty has been lifted in regard to the litigation risk. Sam's Club is still a Synchrony product, so the hit they took from the Walmart loss is now just confined to their Walmart product. This is a big win for Synchrony shareholders, which we're seeing reflected in the share price, but Synchrony still trades for very cheap multiple. They're a very economically sensitive business. Store credit card default rates tend to really move with recessions and things like that. But their profit margin is so great that it would literally take another Great Recession to really put them in the red. So, I think the market's fears in that regard are overblown. We just got some great relief. The business did really, really well this past quarter and this past year. I still love Synchrony as a stock. Shareholders who listened to me last year got handsomely rewarded this past week. [laughs]

Moser: Hey, now, everybody!

Frankel: I wish I would have shut up about it and bought some myself. Unfortunately, that wasn't the case.

Moser: [laughs] Yeah, that's not our job, I guess. But hey, it sounds like all's well that ends well. Good call. I remember the show, talking about that. For listeners, for posterity, go back to that November show, listen to what Matt said because he nailed this one. Good job, Matt!

Let's pivot over to our favorite little payment processor, merchant provider, Square. It seems like they're always in the news. They're apparently in the business of not sitting still, Matt. Last week, the company just released another product to their merchants. This time, it's a business debit card, they're calling it Square Card. It's going to help businesses manage their cash flow by essentially eliminating the time between making the sale and having the funds available. Really, what we've seen, as cash becomes a smaller portion of the money that's being spent, not only here domestically but globally, a lot of this boils down to time and making the funds available. The quicker you can do that, the better off you're going to be. These tech companies are able to build out pretty robust risk profiles that allow them to do that.

I thought that it was pretty interesting. This partnership is actually with MasterCard. You look at Square Cash, that's with Visa, right?

Frankel: Yes, correct.

Moser: What do you think about this debit card?

Frankel: Square's strategy generally seems to be to build their ecosystem as strongly as possible, which is a great business model. It worked really well for Apple. Square's definitely trying to build its ecosystem. The thing that I found the most interesting is that this card offers Square sellers instant access to their money. If, say, a coffee shop uses Square to accept payments. If somebody swipes for a $5 cup of coffee, that $5 is instantly available to the seller through this debit card. They can either spend the money anywhere MasterCard is accepted or access it through an ATM. That's instantly available, which is a big deal. But the thing that really stuck out to me is that Square is offering users of this card a 2.75% discount at any other Square seller. They're incentivizing their own merchants to use other Square sellers to keep the money in the family. That's really a unique way to strengthen the ecosystem.

I think "unique" is my key word when it comes to Square. Like you said, they're in the news seemingly almost every week with some new product, new offering, whatever. All of the things they're using to strengthen their ecosystem are really unique, meaning that no one else is doing this. I don't think the PayPal (PYPL +0.01%) credit card gives you a discount for using another seller that accepts PayPal, just to name one example. Visa doesn't give you a discount for using your card anywhere else Visa's accepted, for example. It's a really unique and innovative way to strengthen their ecosystem.

Competitive risk is everybody's biggest concern when it comes to Square. Is PayPal going to steal their market share? Is somebody else going to come up with a cost-effective way for small businesses to accept credit cards? What's to prevent that from taking Square's business? And the answer is, things like this are what's going to prevent it from taking Square's business. I love this product. I think it's a lot more significant than the market is giving it credit for right now.

Moser: Yeah, a lot of value in the network. That's what we continue to talk about with Square. They've built out a very, very robust network, and they continue to solicit, from their merchant partners, what their merchant partners want the most. They're asking their customers what they want. They get that feedback and they start to build and offer these new products.

I tell you, I was only half kidding when I said it seems like Square's in the business of not sitting still. In this space, in the payments space as a tech company like that, you need to be innovating and bringing new products to market at a rapid pace. It certainly seems like they're doing that. Furthermore, it seems like they're doing it well. It seems like they're bringing products that people really like. It seems like this is a company that's just continuing to do what we've hoped it would do. I suspect that shareholders like us and our listeners feel pretty good about the fact that we all own shares today.

Frankel: Definitely. I still call that the best investment I ever made.

Moser: [laughs] It's not a bad one.

Frankel: The worst investment I ever made was not buying more.

Moser: You have to at least diversify a little bit, right?

Frankel: That's true.

Moser: There's no such thing as a sure thing. But, hey, let them just keep on doing what they're doing and I'll be happy with it.

Let's take a look over Twitter really quick. I just wanted to call out a couple of tweets that came in over the past couple of weeks. Nothing that we really need to respond to, I just thought there were some pretty good pieces of advice worth reiterating for our listeners out there today.

First one here from @MattLazwell. He says, "Remember, being truly diversified means there's always something doing badly, so don't freak out about it." Matt's exactly right. That's the whole point of being diversified. If you have enough diversification in your portfolio, there's always going to be something that's missing the mark. But when you're well diversified, you don't care because you have other winners to pull up the slack there. Good tweet there, Matt!

From @MiloMcMahon -- I'm hoping I'm saying that right, McMahon, because I had a roommate in college, Matt MacMahon, but I think this is Milo McMahon. Milo says, "I'm a firm believer in the theory that retail investors have two key advantages over fund managers. No. 1, we're not under pressure from anyone to do something clever on a day-to-day basis. No. 2, we have a much longer time horizon because our livelihood doesn't hinge on quarter-to-quarter results." I think that is very well said. That's very much in line with how we invest here at The Fool and what we try to talk about all the time on our shows. A good, good point there, and I wanted to make sure to shine a light on those two tweets because I liked them.

Frankel: I think the second one might have actually been from Peter Lynch under an alias.

Moser: Ah, that's possible! There's a lot of good stuff that Lynch left out there for us, for sure.

Alright, Matt, we wanted to jump in here and answer an email. There's an email that we received while we were away. This email came from Petey in Utah. Basically, he's asking us about Zelle. This was the situation. "My wife was going to Vegas for a birthday party with her friend. She owes money to the one that got it all set up. Her friend requested that she Venmo her the funds." His immediate response was, "Hey, just use Zelle," because his wife wasn't using Venmo. Long story short, she used Zelle to transfer the funds. No fees, easy to do. You don't have to download another app. "Can you speak to how Zelle can affect the War on Cash basket?"

It was a good question. I think it's something worth noting, anybody who has a bank account with Wells or Bank of America or any of the big banks probably has access to Zelle. I know I'm a Bank of America account holder and I have access to Zelle. Now, with that said, I've never used it. His question keys in on something that's worth noting -- my initial response to that is that while Zelle is something out there, it's a nice value-add for people who have those accounts, when you look at companies like PayPal and Square and the services they offer like Venmo and Xoom and whatnot, those are services that are being built more for the younger users in mind who are coming up into the banking world as they're growing up.

I look at my kids, for example, at 14 and 12.5 years old. They're a little bit more of that Venmo target versus something like Zelle is with a Bank of America account. That's not to say that Zelle is not a threat. I think Zelle absolutely is going to continue to hold its own. But, it's a very big market opportunity, and I don't think Zelle is something that necessarily threatens smaller companies like PayPal or Square. I do think it probably keeps them on their toes. What do you think about it, Matt?

Frankel: I think the one thing to keep in mind is just how many resources the people behind Zelle have. If you're not familiar, Zelle is a project that was funded by a bunch of the big banks all together. The banks that funded Zelle have something like, $4 trillion or $5 trillion in assets, a ton of resources at their disposal. I think Square is an extremely innovative company, same could be said for PayPal, with Cash and Venmo. Not that it's a threat to Square or Venmo, but it has to keep them on their toes. You think Square is a big company? Square is tiny compared to these banks, same with PayPal. So, it's a question of resources in my mind, when it comes to how much you have to worry about a certain competitive threat. Square and Venmo were the first movers. Venmo, especially, was the first mover there. But I think they still should strive to innovate and one-up the banks and beat them at their own game because the banks have a lot of resources they could throw at building competitive infrastructure if they really wanted to.

Moser: Yeah, you're right. Banks do have a lot of resources there that they can do a lot of things with. That always makes me go back to that idea that, just because a company has the resources doesn't necessarily mean they can execute. You have to be able to actually execute with the resources that you have. I think Zelle is something that's here to stay. We were actually reading through an article here earlier in regard to PayPal and MasterCard executives who are talking about this space and seeing it as such a great time for collaboration with all of these parties involved, big and small. They have opportunities to bring new products and relationships to market for banking customers of all ages. It's interesting when you see the executives from companies like PayPal and MasterCard saying that. Those are obviously two very big and important companies that are doing a lot on their own out there. When you talk about the opportunity to collaborate and do more, they're certainly not viewing this as a zero-sum game. They're not viewing this as win or lose. This is something where it's a big enough market opportunity that there are a lot of different ways these companies can all succeed. I think that's ultimately the way we look at it. We've talked before, certainly, about the War on Cash. I could have probably thrown five more companies in that basket if I wanted, I just drew the line at four.

Anyways, a very good question from Petey in Utah. We enjoyed having the chance to talk about it a little bit. Thanks, Petey from Utah, for emailing us that question! And, hey, listeners out there, remember you can always email us any questions at [email protected]. You can hit us on Twitter @MFIndustryFocus.

Before we wrap things up here, Matt, let's get to One to Watch. Earnings season really kicking in now here, shouldn't be very hard to find something to keep on your radar for the coming week. What's your One to Watch?

Frankel: Now that the big banks have already reported, I'm looking at a smaller one, Axos Financial (AX 0.01%), AX, which a lot of our listeners know better as BofI or Bank of Internet. They report tomorrow. Their stock has really underperformed the sector recently. A lot of questions about whether they're going to be able to maintain profitability and all their competitive advantages going forward. I'm looking at their earnings report to see how they're doing growth-wise, what their plans coming up are. I know they've made a few big acquisitions like a Nationwide financials deposit portfolio, and how they're planning on implementing that. It's going to be a really interesting earnings report to watch because the stock has gotten so much cheaper lately.

I'm a shareholder, and I wouldn't be opposed to adding more if I get some really good growth figures from the company when I see it tomorrow. So, that's what I'm watching this week.

Moser: OK, and what's the ticker?

Frankel: AX.

Moser: All righty. Well, I'm going to be focusing on a little company called Apple (AAPL +0.01%), AAPL. Apple earnings are also out tomorrow, Tuesday, after the market closes. With all of the noise about iPhones and missing iPhone targets and whatnot, it seems to me to be missing the mark a little bit. Listen, as iPhones get better, they should last longer, so I'm not sure what everybody is so upset about this for.

I think that with a company that's focusing on moving more toward services revenue, one of those avenues, one of those drivers, is going to be Apple Pay. I'd love to hear more about Apple Pay on the call. My hope is that going forward, we will hear more about Apple Pay, particularly as we see this move toward cashless gaining traction. That's going to be what I'm focusing on with Apple earnings tomorrow.

OK, listen, Matt, I think that's going to do it for us this week. As always, it's great talking with you! I'm glad we were able to make this happen today!

Frankel: Yeah, feels like a while since I've Skyped one in. We were off for a week, and I did one in person. It's been a while since I've been on this end.

Moser: Absolutely. Just a quick reminder for our listeners, I wanted to let you know that we have an interview with Ameris Bancorp CEO Dennis Zember that will be hitting next week's show. We're going to drop part 1 of the interview on next week's show, then we'll drop part 2 of this interview on the following week's show. Listeners would know Ameris Bancorp, it's a company I've talked about a lot. It's one where I have a lot of optimism in what they're doing. Dennis and I spoke for a little bit about the things that they're doing. He told some stories about the financial crisis. A really fun interview, I think you'll get a lot out of it. Look for part 1 of that interview to drop next week, and then part 2 the following week.

As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. For Matt Frankel, I'm Jason Moser. Thanks for tuning in! We'll see you next week!