What To Expect From Ally Financial's Q2 Earnings

Despite financial stocks taking a breather over the last month, they're still some of the best performers of the year so far. Digital bank and car lending giant Ally Financial (ALLY 6.73%) is up 43% year to date at Wednesday's prices, and 337% from its pandemic low point set in March 2020 -- driven by record earnings amid favorable conditions in its key operating markets. 

The company is set to release second-quarter earnings on July 20. Analysts anticipate further gains in the key metrics, adding to what they're expecting to be the best full-year result in Ally's 102-year history. It's no surprise given the frenzy in the auto market this year, which is the company's biggest segment, but some recent data shows the momentum may have taken a negative turn.

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Autos are robust, with a catch

The pandemic caused heavy disruptions to major supply chains in the car manufacturing business. Semiconductors are the main culprit -- cars have become increasingly sophisticated and therefore require more advanced computer chips, but the main producers can't keep up with record levels of demand.

The result has been a dramatic shortage of inventory on dealer lots across America, leaving consumers with very few options. In some instances, dealerships that routinely keep hundreds of cars on the floor now have 80% less stock, which has forced desperate buyers to explore the used-car market instead. As could be expected, with thin supply and soaring demand, prices for both new and used vehicles have hit record highs in 2021. 

This is a big opportunity for auto lenders like Ally, as higher prices mean bigger loans and more interest income. 

But there are early signs of a slowdown on the horizon. According to data in the University of Michigan's survey of consumer sentiment (May), just 48% of consumers thought it was a good time to buy a car. It was the lowest result of the prior 12 months, with a high of 68% set in June 2020 -- and it was also the only time it dipped below 50% during the period. 

Additionally, used car sales were down 11% last month, but this was offset by an 18% increase in new car sales -- which might suggest the backlog is clearing and consumers are back to buying new vehicles. If this is the case, prices should fall further and sentiment might begin to tick back up.

Auto finance made up 80% of Ally's first-quarter pre-tax income, so the robustness of the industry is a key indicator for the company's earnings performance. Any increase in new car sales is encouraging, given the company's 19,000 car dealer relationships.

Second quarter expectations

With 48 consecutive quarters of customer growth, it's unlikely that momentum will reverse in this quarter. There is still an incredible amount of strength in the automotive industry, where Ally holds $103 billion worth of loans, and housing is red-hot -- which is an important growth area for the company.

According to Yahoo! Finance, a group of 18 analysts are expecting 137% year-over-year growth in earnings for the second quarter (on average). 

DATA SOURCE: COMPANY FILINGS.

In Q1 2021, Ally saw a rather significant $9.9 billion year-over-year decline in the size of its auto loan book. That was mainly driven by the persistent supply shortages at car dealerships, and it's important that the trend reverses given the big June increase in new car sales. 

Ally really ramped up home loan originations in the last couple of quarters. It's a new market for the company, but Q1 originations were up 157% year over year, so this is a growth area investors should focus on as Ally works on applying its digital lending approach to mortgages. 

Overall, it's hard to ignore the potential for an upside surprise to Q2 earnings. In Q1, the company delivered $2.09 per share, beating analysts' average $1.18 forecasts by 77% -- triggering a key vote of confidence from a major investment bank.