Synchrony Financial (SYF)

[TRUISM]

Synchrony Financial: Largest Pure-Play Private Label Credit Card Issuer
Sep. 10, 2014 2:59 AM ET |

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Summary


* SYF is the largest pure-play private label credit card issuer in the U.S.


* It is well positioned to benefit in the near-term from the continued expansion of consumer credit.


* In the medium-term there is upside from rising capital return post the separation from GE.



Synchrony Financial (NYSE:SYF), the consumer credit card business of GE Capital, is the largest provider of private label cards in the U.S. in terms of both purchase volume and finance receivables ($56 billion of receivables). The company operates through three sale platforms: Retail Cards, Payment Solutions, and CareCredit. Retail card business, which provides private label and dual card through national and regional partners, is the largest contributor of revenue. It accounted for about 80% of 2013 total purchase volume. Payment Solutions provides promotional financing for major consumer purchases such as electronics, appliances etc. while CareCredit provides promotional financing for elective healthcare procedures.

Being the largest pure-play private label card issuer in the U.S, Synchrony Financial is well positioned to benefit from the continued expansion of consumer credit. While there are opportunities in the near term as the U.S. consumer continues to improve, driving strong loan growth and credit card spend. In the medium term, there will be upside from rising capital return post the separation from General Electric (NYSE:GE). SYF plans to spin out from GE in late 2015 and become a fully independent entity subject to 2Q16 CCAR.

Largest Pure-Play Private Label Credit Cards Provider

SYF is the leading provider of private label credit cards [PLCC]. It is the largest private label card issuer based on purchase volumes and receivables. The company's origins date all the way back to 1932 when GE launched its consumer finance business to help finance GE appliances. Private label credit cards align the interest of the merchant, borrower, and issuer. Since the private label business requires specialized management expertise around retail marketing and promotion, it isn't so easily replicated by card issuers focused on the general purpose card business. The return on private label can be quite attractive and SYF benefits from its positioning as the biggest player with partnerships with many of the largest retailers.

Synchrony has partnerships with some of the largest retailer including Wal-Mart (NYSE:WMT), J.C. Penney (NYSE:JCP), Lowe's (NYSE:LOW), and Gap (NYSE:GPS). Many of these partnerships are long-standing relationships and have been in place for decades. This large portfolio of national and regional retailers allows SYF to be diversified across industries and geographies. For example, the company's credit products are offered across 329,000 retail locations across the country. Moreover, 32 of the company's top 40 programs are locked up until 2016 and beyond. This represents about 70% of the company's total platform revenues.

SYF's direct partnership with merchants allows it to lower its cost of acquisition as a large proportion of customers are acquired at the point of sale. The company also has less marketing expenses than standard credit card operators as part of the marketing costs are borne by merchants.

New Partners and Increase Penetration of Existing Partners

One of SYF's largest opportunities is the potential organic growth with existing partners. The aggregate sales of all the retail card partners is more than $550 billion compared to just $75.7 billion purchase volume in retail cards. While the company has higher penetration in small to medium retailers, there is significant room to increase penetration at the mass merchants, where penetration is typically low. For example, with some small to medium sized retailers penetration is as high as 40% but less than 5% at some of the bigger retailers. SYF has huge opportunity to drive organic growth via increased penetration of existing partners. Synchrony has more than 1000 employees dedicated to individual retailers to drive strategy and execution.

The company is also seeking to attract new partner relationships. While SYF's partnership already includes many of the largest retailers, it is more likely that the company will add smaller partner relationships rather than large ones. While the company's long history and leadership position in PLCC should help SYF win new partners, the company at the same time also continues to invest in online and mobile technologies to attract new partners. For instance, the company intends to roll out the capability for consumers to apply for credit as well as deliver targeted rewards and promotions via mobile devices. Synchrony also plans to utilize its data and analytics from its large customer base with the goal to improve the effectiveness of marketing strategies with their partners.

Should Benefit from Increasing Retail Spend

Improving income, employment, and consumer confidence are driving higher retail sales, which is a positive for SYF revenues. Retail sales, measured by the 3-month moving average, accelerated from 2.5% y/y increase in 1Q14 to 4.5% y/y increase in 2Q14. Moreover, spending at SYF's key partners including WMT, JCP, LOW, and GPS is expected to continue to grow. Given that Synchrony is able to offer its cardholders significant spending incentives through higher and more customized discounts, spending volumes on Synchrony's PLCC typically grow faster than total retail spend at their partners.

Capital Returns Following Full Separation

SYF's IPO earlier this year was the first step in separating the business from General Electric. The IPO resulted in GE owning 85% of the outstanding shares currently. The second step of the separation will involve GE exiting its ownership through a split-off, which may be affected through a tax-free distribution of GE's remaining ownership to electing GE's stockholders.

Full separation will be subject to various regulatory approvals and the process involves the Federal Reserve Board's determination that SYF is prepared to operate as a stand-alone entity. On that front, the company will be taking a number of steps to prepare itself as a stand-alone company. These steps include reducing or even eliminating the funding provided by GE Capital, diversifying funding sources, and increasing capital and liquidity levels.

These actions are already resulting in strong capital ratios. Moreover, the company also does not plan on returning any capital in the near-term until the full separation from GE. SYF has a strong Basel III CT1 ratio of 14%, which is in-line with 15.1% Discover Financial Services (NYSE:DFS), and higher than 8.4% and 13.4% of Capital One (NYSE:COF) and American Express (NYSE:AXP) respectively. With strong capital generation combined with no expected dividend until 2Q16 and no share repurchase until 2017, Synchrony should continue to improve its capital ratios.

I expect SYF to have a conservative capital position to reduce risk of delay in separation. This will leave SYF with significant excess capital post its separation from GE and positions the company well to start to return capital in its first start-alone stress test in 2016. I believe SYF will look to return capital in the middle of 2016 and gradually increase payouts as the company gets more comfortable with the stress test process.

Conclusion

Synchrony Financial is the largest pure-play private label credit card issuer in the U.S. The company is well positioned to benefit from the continued expansion of consumer credit during what will be a prolonged period of benign credit after the 2008 financial crisis. SYF's private label card business is embedded at the retailer level and should continue to benefit from higher consumer spending as the economy continues to expand, consumer confidence increases, and the unemployment rate declines. While the rising payrolls, stronger consumer confidence, and improving net worth should drive strong loan growth and credit spend in the near-term, in the medium term there is upside from rising capital return post the separation from GE.


Note: All the figures in the article are taken from SYF's SEC filings which can be found here.



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