When a stock is undervalued, it typically means that its share price does not reflect its overall intrinsic value or earnings power. For some reason, the market has not discovered its value, at least as measured by some key indicators.
Generally and/or eventually the market does catch on and, after a period of sustained performance, the price goes higher. As an investor, the opportunity comes from getting on board before it does so you can ride that wave to higher returns.
One undervalued stock in particular that looks like a good buy right now is Alliance Data Systems (ADS +2.11%).
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Stock price surges on strong earnings
Alliance Data Systems is a company that operates in two major segments: credit card services, through which it provides private-label and co-branded cards for corporate clients, and loyalty programs through its LoyaltyOne business. LoyaltyOne operates out of Canada and includes the Air Miles Reward Program.
The company has had a brutal past few years, ending the year with negative annual returns in five of the last six years dating back to 2015. This year, the stock price is up 24.5% as of Aug. 3, buoyed by solid earnings and a series of strategic moves that set the company up for long-term success.
With regards to earnings, Alliance Data generated $273 million in net income, or $5.47 per share, in the second quarter, a more than 600% increase year over year. Most of that gain stems from a huge $250 million provision for loan loss set aside a year ago during the quarter. This past quarter, the company had a $14 million reserve release, boosting earnings.
Revenue was up about 3% year over year, led by the credit card services, which were up 4% to $861 million. The company added several new card services partners, including retailer rue21 and website GasBuddy, and its credit sales were up 54% year over year. Alliance Data has more than 135 card partners, including Victoria's Secret, Caleres-owned Famous Footwear, Blue Nile, Lane Bryant, and Ann Taylor, among many others.
Furthermore, the net loss rate was 5.1%, below the 6% historical average, and the delinquency rate was 3.3%, down from 4.3% a year ago. The gains were in part propelled by an improved economy and higher consumer spending, but those weren't the only factors at work.
Strategic moves put Alliance Data on a good path
The company has made a series of moves in the past 18 months to get its financial house in order and set it up for future growth. First, it hired Ralph Andretta as president and CEO in February of 2020. Andretta is a respected industry veteran who came from Citigroup, where he ran the U.S. cards business. Before that, he worked in the credit card division at Bank of America and American Express.
Then this past April, it hired a new CFO, Perry Beberman, from Bank of America, where he was an executive in the consumer and wealth management lending products division.
One of the first major moves that Andretta made was to acquire Bread, a buy now, pay later (BNPL) payment platform for merchants at the point of sale. This platform allows Alliance Data to expand its relationships with its brand partners and opens it up to new clients and revenue opportunities. BNPL is a fast-growing segment of the payments market. A survey by The Ascent, a personal finance brand by The Motley Fool, found that the number of consumers who used BNPL services grew by 56% in the past year alone. Square just got into the BNPL game, buying Afterpay this month.
Also in April, Alliance Data signed a deal with Fiserv to use its merchant acquiring services for its Bread clients. On the second-quarter earnings call, Andretta said the Fiserv deal provides an opportunity to scale the Bread platform beyond the direct distribution model, while "delivering enhanced payment and servicing capabilities and realizing additional efficiencies."
Spinning off LoyaltyOne
The other big move that Andretta spearheaded is spinning off the LoyaltyOne business into a separate, publicly traded company. It will allow Alliance Data to focus on its growing card-services business and improve its financials since the net proceeds will be used to reduce the companyʻs debt. The spinoff is scheduled to occur in the fourth quarter.
These moves, combined with an improving economy, will help transform Alliance Data Systems into a more focused, efficient company with significant new revenue opportunities from the Bread acquisition.
Alliance Data is currently delivering a 49% trailing-12-month return on equity for shareholders with a solid operating margin of 28%, showing its efficiency. And with it trading at just 5 times earnings with a low price-to-earnings-to-growth ratio of 0.59, it is a great time to buy -- before everyone else does.
