Ally Financial Continues Its Record Earnings Streak

After closing 2020 with back-to-back historic quarters for earnings, Ally Financial (ALLY -0.77%) has carried its momentum into the new year. In the first quarter of 2021, the online-only bank delivered another company record with $2.09 in earnings per share, primarily driven by strong operating income in its core auto finance business. Combined with accelerated growth in its much younger mortgage lending arm, Ally's stock is well positioned to outperform as U.S. consumers continue to emerge from the pandemic. 

Image source: Getty Images.

Ally Home

Ally Financial -- a century-old financial institution -- is the leader in car financing in the U.S., holding over $100 billion in loans. This primary business accounted for about 80% of the company's operating income in the first quarter. 

At the end of 2016, Ally sought to diversify its business with a move into direct-to-consumer mortgage lending, launching Ally Home. It leveraged its technological experience in consumer-originated auto finance to create a digital, online process for mortgages. Growth has been really impressive: After writing $300 million worth of home loans in Q1 2017, the company just did $1.8 billion in Q1 2021 -- a 500% increase, and an all-time quarterly high. Sequentially, this represents 28% growth over the fourth quarter of 2020.

Despite the growth in originations, Ally's overall home loan portfolio has shrunk by 22% over the last 12 months. The company attributes this to highly elevated prepayments by customers, who are getting ahead on their mortgages. Regardless, originations do generate revenue, demonstrated by the company's 100% increase in quarterly mortgage operating income measured year over year. Ally has guided expectations for $10 billion in yearly originations over the next couple of years, which should propel its mortgage book back to growth.

Ally Home accounted for just 2.3% of the company's total operating income in Q1 2021, but this is up from 0.9% in Q1 2020. The home loan segment is only a few years old, and it is growing against the backdrop of a mammoth auto financing business, which is firing on all cylinders. 

The focus for investors should be the billions of dollars in new originations, as this is where additional income might flow from.

Earnings acceleration

Since posting a company earnings record of $1.25 per share in the third quarter of 2020, Ally has delivered accelerating growth. Generating sequential historic numbers is quite a feat. 

Data source: Company filings.

The $2.09 Q1 number smashed analyst expectations by about 80%, sparking a $59 price target at Morgan Stanley. It's the third increase this year by that firm -- previously $51, followed by $56. With the stock trading around $48 on Thursday, the new target represents 23% upside! Given the earnings trend, this likely won't be the last -- or the highest -- upside share price revision by analysts. 

Data source: Yahoo! Finance. Estimate is the average of 16 analysts. As of April 19, 2021. 

Earnings estimates by the analysts who cover Ally Financial have risen substantially just in the past few months. Since January, the average estimate is up almost 30% from $4.05 to $5.20, on the back of the huge earnings beats at the end of 2020, and Q1 2021. 

Should the company deliver the consensus $5.20 per share, a 10 times earnings multiple would mean a share price of $52. However, since growth is strong, the company could attract a multiple closer to 16 times, which is near historical averages for the S&P 500. That could mean a share price of over $83 -- or 73% upside from today's price. 

The KRE, an S&P 500 regional banking ETF, is up roughly 135% since its pandemic lows in March 2020. By comparison, Ally Financial has risen almost 300% over the same period, significantly outperforming. Given increasing earnings estimates, the company stands to continue this trend. 

Set to continue

Ally's auto financing business generated $803 million in operating income in Q1, a 42% jump compared to Q4 2020. This continues to drive the company's post-COVID resurgence, as its largest segment.

Total auto loans, however, shrank by $3.2 billion to $103 billion quarter over quarter, caused by low inventories of new vehicles on the commercial side. This kept prices higher and more than doubled the company's average gain per vehicle on leases, which cushioned some of the negative effect. 

It is estimated that the U.S. is still in the early innings of a consumer-driven economic boom, with 7% GDP growth expected in 2021. With over $5 trillion in government stimulus still working its way through the system, and potentially trillions more coming via an infrastructure package, consumer demand for high-ticket items like cars may not peak until the end of the year. 

As supply chains recover from pandemic-related disruptions, expect new vehicle inventories to tick up later this year, feeding some of the pent-up demand that has kept prices elevated. With over 19,000 dealer relationships, more cars delivered means a growing loan book for Ally. In addition, housing demand should remain steady as single-family home shortages persist, which could provide a growth opportunity for Ally Home.

Investors should watch for continued earnings acceleration from the company, as this economic boom might just be getting started.