With the collapse of Silicon Valley Bank and Signature Bank, some investors now have elevated fears about the banking industry. While no other banks have collapsed since mid-March, there have been consistent reports and predictions out there about trouble brewing in commercial real estate, private equity, and the new/used car markets. This has kept Wall Street on its toes and bank stock prices depressed.
Ally Financial (ALLY 0.41%) is a growing consumer bank and leader in the automotive lending space. The company just reported its financial results for the first quarter, updating investors on its deposit base and the state of the car market. Here's what management had to say and what it could mean for Ally's stock going forward.
Growing deposits, fully insured
Ally's business works by taking in low-cost deposits from individuals and then making loans, usually for purchases of new and used automobiles. This is the classic banking business model that has been around for decades.
Even with fears of depositors fleeing to the big banks in March, Ally's deposits grew $800 million quarter over quarter and $2.5 billion year over year in Q1. It now has 2.8 million Ally Bank depositors, $138 billion in retail deposit balances, and has grown its retail deposits for 14 straight years. This is the sign of a healthy banking operation (at least on the funding side), giving Ally a steady flow of capital that it can then lend out and earn a net interest spread on.
Of course, with rising interest rates at the Federal Reserve, Ally has been forced to increase the annual interest it pays to customers, which rose to 3.16% in Q1 vs. a measly 0.59% a year ago. This has reduced its net interest margin (NIM) from 3.9% in Q1 of 2022 to 3.5% last quarter.
Worries about the automotive market?
Many stories have been written about consumers being unable to afford to purchase cars, specifically within the used car market with prices soaring due to supply chain crunches and rising interest rates. Ally has direct insight into the market as it is constantly making loans to consumers who need financing for vehicle purchases.
According to management, Ally is currently being more conservative with its lending decisions, increasing its ultra-creditworthy loans and decreasing its guidance for total loan originations in 2023 by a few billion dollars to $40 billion. It also expects used car prices to fall 15% from current levels, which would negatively affect all companies in the automotive space. However, the company has not seen a huge increase in net charge-offs on its automotive loans (1.68% last quarter), meaning that so far customers are paying off these expensive-looking loans at historical rates. This is well below its current $3 billion automotive loan reserve -- 3.6% of its outstanding loan book -- which means that the automotive market would need to get much worse before Ally runs into any trouble with its lending business.
To sum things up, Ally is indicating that while it is preparing its balance sheet for deteriorating economic conditions, it is not seeing any looming concerns with its loan book right now. If used car prices continue to decline, the company's balance sheet is also prepared to take the hit.
Is the stock cheap at these prices?
Banks are unique businesses. Unlike an operating company where you might value it on a multiple of cash flow, operating income, or earnings before interest, taxes, depreciation, and amortization (EBITDA), the best way to value a bank is by taking its assets minus liabilities, commonly called its book value. On a per-share basis, Ally Financial trades at a book value of $36.75, which is well above its current stock price of $27. It has also consistently grown its dividend payouts while opportunistically reducing its share count through share repurchases. Its dividend per share is up 140% over the last five years (currently yielding 4.5%) while its shares outstanding are down 30%.
ALLY Shares Outstanding data by YCharts
Yes, Ally's book value per share declined from $39.99 in Q1 2022, but that was an abnormal time period when earnings were elevated due to soaring used car prices. Ally is now working through a normalization of the car market, which is hurting book value in the interim. But over the long term, Ally has shown a consistent ability to grow its business, with more than 14 years now of retail deposit growth that it uses to make loans in the automotive market.
Taking this long view, I think Ally is a cheap stock to own today that can put up strong returns (in both the share price and dividend growth) this decade.
