Category: Security Analysis

Why Hasn’t Autozone Stock Re-rated with Other Pandemic Winners? $AZO #COVID19

I just did a post where I evaluated my holdings of Apple following its recent surge, which looks to be a quite big move for the US’s largest public company. One thing I didn’t really discuss in that post was that Apple may have re-rated recently due to perception of it being a pandemic winner. If your sales have held in well this year, or even increased, you are viewed as either defensive or on a continued growth trek. In turn, your stock has rocketed up.

Here’s a list of stocks that I would say fall into that category. I can’t include them all, but you get the point:

FB Chart

FB data by YCharts

The S&P total return is ~5.5% at this point in the year.  Home Depot is doing well because housing is holding in well, and the pandemic is causing people to reinvest in their homes. Same store sales were up ~24%+! No wonder Home Depot has surged.

The same is true for other retailers, such as Target or Wal-mart, which despite possibly missing the back-to-school shopping season (which is big bucks) they are reporting some of the best comps in years.

So let me take off some of the true high fliers and compare Autozone stock and other auto part retailers to these names.
FB Chart

FB data by YCharts

If you’re having trouble finding the auto retailers on this busy chart – they’re all at the bottom!

This is odd to me. O’Reilly reported +16% SSS comps for Q2 and a 57% increase in net income. Advance Autoparts has a different fiscal period, but they reported 58% increase in EPS on a 7.5% SSS comp.

Why is that? There are several reasons.

  1. In recessions, people keep their car longer and do more work themselves. See my post on AutoZone for some discussion on their comps after the 2008 financial crisis.
  2. After reaching about 7 years in age, cars tend to need more work. The average age of a car in the car parc today is around 12 years
  3. Retailers focused on cleaning products and other pandemic needs consumers would need and auto parts took the back seat. It’s likely that the pure-plays auto stores picked up share

So I fully expect Autozone’s sales to benefit when they report at the end of September. And if this current crisis persists, then their increased comps will likely persist as well.

I’ve been watching street estimates for Autozone. They still sit around pre-pandemic levels. My guess is AZO handily beats these estimates, though admittedly there are some tough comps (believe there were additional selling days in the prior year).

Look, I’m a long term holder at the end of the day and I wouldn’t recommend trading around a  quarter. All I’m saying is you have (i) a high ROIC business that (ii) historically has returned every dollar of FCF to shareholders that (iii) is probably benefiting in COVID where (iv) estimates might be too low. I like the set up.

Should you hold Apple stock here? $AAPL

I’m an Apple shareholder and the meteoric rise in Apple stock has me questioning whether I should hold on or move on.

One problem with this, and why I don’t think Buffett will sell, is opportunity cost. Selling Apple stock to hold cash isn’t really a great option right now. Yes, yes, cash has option value in itself, but the only reason why I’d be selling is my scant perception is that Apple stock has gone up really quickly and so maybe it is “fully valued” at this point.

Personally, whenever I sell a really high quality company due to valuation – that ends up being a bad decision.

Think about what this would mean right now if you count yourself as someone who is a “traditional” value investor (i.e. someone who looks for low P/E stocks) – this means selling a really high quality company to probably go invest in a lower quality company trading at a low multiple. Not a particularly great trade-off in my view. That multiple is probably low because of low growth, low ROIC, high cyclicality or some other reason.

If I stay on this broad topic, I also think the market is rarely so grossly wrong on a blue chip, top component of the S&P500. Yes, we have had instances in the past where everything just gets overbid in a mania (a la, the tech bubble where even GE was trading at 50x earnings). Also there are plenty of cases where the leaders of the S&P at  the start of the decade aren’t there by the end of it. But largely the market is a pretty good weighing mechanism.

In sum, tech bubbles are rare. But the stock market being a pretty good estimator of company value? Not so rare.  One reason why active management is so hard.

Frankly, if you’re reading this and thinking the stock has gone up too much, you’re probably anchoring to when Apple stock traded at 14x EPS and now trades for 30x without really much thought as to why 14x was right / wrong and 30x is wrong / right.

Ok, back to my view on Apple’s valuation. What do we need to believe here?

First, I like to go a look at Apple’s estimates for some expectations investing. I see that consensus is expecting the company to generate ~$75-$80BN of FCF for 2022-2023.

So let’s say they generate $77.5BN and using a short-hand 20x multiple of FCF (or 5% FCF yield), that’s a $1.5 trillion valuation. Wow. That would be a $363 pre-split price compared to $487 price at the time of writing. What else am I missing?

Well cash on hand is something else. Apple has $93BN of cash & equivalents (another $22/share) plus long-term investments (which is essentially Apple’s hedge fund) which is another $100BN (or $23/share). Yes, Apple has $100BN of debt, but they could have $0 of cash, be 2.0x levered and still be high investment grade. I’m not concerned whatsoever about that debt, so don’t view it as unfair to net the cash.

Add the cash together with the value of the business and you get $363 + $45 of cash, for a quick-hand value of $408 / share. Now, all of this was a very cursory estimate. For example, I change my math from a 5% FCF yield to 4% FCF yield, the price I get is $498/share. At this point, it’s hard for me to say that 4% is any worse than 5%.

I traditionally say my equity IRR over the long-term will approximate the FCF yield + the LT growth rate in the stock. So a 10% FCF yield in a low-to-no growth industrial will probably be around the same return as a 5% grower at 5% FCF yield (as long as you have long-term confidence in the FCF ). Can Apple compound earnings at 6% from here for a 10% total return? Maybe not, but all they need to do is 3% for a 7% return. And for an annuity-like business like Apple, that is as Larry David would say – pretty, pretty… pretty good.

Right or wrong, in a world of 0% interest rates, consistent cash generators will be bid up pretty high. Here’s a quick sample of companies and their FCF yields for 2021. Apple comparatively doesn’t seem crazy.

Of course, there are some other drivers for Apple recently.

The core driver for Apple here has to be the upgrade “super cycle.”

    • If you’ve been invested in Apple for a long time, you understand the stock goes through cycles and I’ve written about it in the past. It’s frankly frustrating, but the function of short-termism.
    • To rehash it, Apple’s sales go through a lull as a large proportion of users upgrade every 2 years or so. So there are big booms and then lulls and the Y/Y comps don’t look great.
    • That’s also when people hark back to the good ol’ days of Steve Jobs and say Apple can’t innovate anymore (right, like the iPad, Watch, AirPods and software moves show the lack of innovation…).
    • The story really has always been the same, but bears repeating. You don’t buy iPhone for the phone, you buy it for iOS. It has always been a software company and they continuously expand on that (AirPods being the latest hardware move, health monitoring seeming to be the next).
    • Heading into a new phone cycle is when people start to realize better results are on the come (and I have no back up, but I would say leading up to the launch is great, after launch Apple then starts to underperform again as people typically expect them to announce a new UFO and are disappointed when it’s just a new phone everyone will buy).
    • ANYWAY – the next upgrade cycle could be huge, especially if Apple is able to launch it with 5G with meaningful new speeds. I’ve seen estimates saying that nearly 40% of iPhone users are due for an upgrade. That would be a huge boon to Apple.

Apple’s bundling could create a “services” powerhouse

    • First you need to understand how profitable “service” business are. Apple has 64% GAAP gross profit margins for services. I assume its CAC must also be much lower than other players, again because of the iOS ecosystem
    • Services is growing well and could become a higher and higher % of earnings over time. Services gross profit has nearly doubled since the end of FY2017 and is now $31BN.
    • Something else to think about: Apple grew Service sales by nearly 15% Y/Y in the latest Q. But COGS only rose by 5%. That’s big operating leverage.
    • These recurring revenue streams are not only valued highly, but has a positive feedback loop in keeping everyone in Apple’s ecosystem!
    • Apple next launched “bundling” most recently and this could be a game changer.
    • Apple reported on its Q3 call that, “we now have over 550 million paid subscriptions across the services on our platform, up 130 million from a year ago. With this momentum, we remain confident to reach our increased target of 600 million paid subscriptions before the end of calendar 2020”
    • Those are huge figures in comparison to a Netflix and Spotify which have 193MM and 140MM paid subscribers, respectively.
    • Again, I view this as classic Apple. They changed the game with iTunes and made it tough to compete. The same could be true with whatever they bundle.
    • Apple could bundle Music, TV+, News, Cloud storage, as well as new growth arenas like gaming and perhaps health monitoring. Charging a low price for all these services / month might mean low profit at first, but huge scale benefits. You also drive your competitors down.

Bundle services… Bundle hardware

    • What if you were offered $100 off a product bundle if you bought a watch, iPhone/Mac, and AirPods together? Look, I only have 2 out of the 3, but I’d be tempted.
    • Apple wins despite the discount because they move more hardware and increase adoption of the iOS ecosystem
    • Then they push the software bundle. Rinse and repeat.

Each of these items make it a bit more exciting to be an Apple shareholder, but more importantly, they may be things that current estimates don’t factor in yet. In other words, especially the latter two items here, there could be further upside surprises.

Nothing I can see jumps off the page to me to say, “holy cow – GTFO.” So I’m staying put.

Is it Time to Buy Cruise Stocks? Pt 2 $CCL $NCLH $RCL #COVID19

It’s always a pleasure to share these pages with like-minded people. Today’s post was written by a very smart, very diligent guy — who just so happens to be a long-time friend of mine. During COVID-19, he’s scrutinized one of the most “center of the storm” sectors: the cruise line stocks . I was thrilled when he accepted the invitation to share his thoughts and work on the blog. I know you will be, too.

With almost five months of lockdown behind us, logic would tell most that the outlook for the cruise industry has gone from bad to worse. As you’d expect, most cruise lines have spent the last few months pulling together survival dollars for what could be the worst storm to hit while not sailing. But even in the darkest of times, could there be light at the end of this tunnel? Article #Is it Time to Buy Cruise Stocks? Intrinsic Value Impact from Coronavirus identified what I think is a very counterintuitive point – even when some of the most horrific events have hit cruise lines, their demand has been remarkably resilient in the following year(s).

For those who like bottom lines up front – I think CCL probably has best chance of survival, and a lot of assumptions used in this analysis are pretty conservative. This is a big gamble, and I’m not expecting any potential pay off until 2022 at the earliest (although reckless day traders may create some wild ups and downs along the way), but the payoff could be exceptional.

The case for strong demand recovery

So what happened after a massive pandemic hit, confining people to their homes in March and April…see Carnival swamped with cruise bookings after announcing August return or What pandemic? Carnival Cruise bookings soar 600% for August trips. When CCL announced cruise returns in August 2020, bookings shot up, with the spike reflecting a 200% increase in bookings over the same period in the prior year.

Who are these people making these bookings? Will these spikes in demand last? Even if there is strong demand, won’t governmental restriction stymie all chances for recovery here?

All great questions. The first two cannot really be answered definitively. If the past can be used to determine the future, it is fair to say that cruise demand has historically come back strong even after disastrous events. Further, many people seem to be of the mindset that Covid is here to stay, and are accepting its spread while hoping for a low death rate (whether this is an ethically acceptable position is an entirely different discussion and far out of the scope of this article’s analysis).

The last question is probably the most important here – where does governmental restriction fit in all of this? In my opinion, it is the most important final step in the recovery. If demand is there, but governments forbid sailing, then demand becomes irrelevant. Your guess is as good as mine here, but demand assumptions for the rest of this analysis are:

  1. No more cruises will sail in 2020 – only revenue accumulated was Q1’20, with a complete halt to revenue for the remainder of the year.
  2. Demand in 2021 is 50% of what it was in 2019.
  3. 2022 resembles normal operations – EBITDA falls somewhere between the min and max annual EBITDA generated in 2017, 2018, and 2019.

After diving into the financials of CCL, RCL, and NCLH (“The Big 3”), it looks like these three cruise lines have the ability to survive into next summer with no cruise activity. While some of these may be able to last longer, failure to resume sailing in the peak season for cruises (i.e. the North American summer months) would likely be a final dagger for these businesses. CCL looks best poised to survive of the three, so more of the below will focus on them. Note that as of date of this post, cruises in the US will not resume until October for The Big 3; however, some European cruises are still scheduled to go ahead as planned.

Survival – what does liquidity look like over the next year?

Let’s start by getting perspective on what debt looked like on the balance sheet for The Big 3 pre-Covid. Looking at Net Debt to EBITDA and FCF as a % of Debt (avoid using equity in this kind of assessment, as companies can mess with it via share repurchases, dividends, etc):

CCL looks best capitalized coming into this mess, and has traded cheaper in comparison to the other two – EV/EBITDA ratio is ~20% less than the other two at the end of 2019.

As you’d expect, over the last few months The Big 3 have moved quickly to build up liquidity to survive this next year, drawing down revolvers and issuing new debt. Some of the debt issued at CCL and NCLH are convertible notes, so assuming these companies recover I think it’s important to factor dilution into any analysis that you run. NCLH also took in additional equity investment from both the public and via PIPE from L Catterton.

Now let’s put together some pro formas for CCL. What does a projected income statement look like?

As expected, these next couple years look rough, but I’d like to reemphasize that 2020 assumes no additional revenue, and 2021 assumes 50% demand – unless Covid goes from bad to worse than we could have ever expected, these feel conservative. This analysis also does not bake in the benefit of reduced fuel prices that may stick around these next couple years.

Where does this get my cashflows?

Using rough numbers here, analysis projects that $7.3bn of financing is needed over next couple years ($3bn in 2020 and $4.3bn in 2021). The good news (depending on how you look at it) is CCL pulled $3bn from revolvers in March and issued $5.75bn of new debt in April (some of which is convertible, and should be assumed converted if CCL recovers), meaning they’ve already achieved the financing needed based on these projections. My above cashflow projections also assumes all treasury shares are reissued at approx. 80% loss, and per the below, 62.5m of the 190m shares have already been reissued.

Other comments on cashflow:

  • 2020 sales of shipsCCL plans to sell 13 ships in 2020 (approx. 10% of its fleet). I assumed $150m sale price per ship in my above cashflow estimates. I don’t think this is actually that alarming, as (1) these ships are probably older, and needed to go at some point anyway (who wants to ride an old cruise ship), and (2) 10% of fleet isn’t that bad given that they are the biggest cruise operator with ~45% market share. Competitors have also done and/or will probably do the same.
  • Cash outlays for ship orders- I’ve assumed that commitments for new ships will be wiped out over next few years. I think it’s fair to assume that CCL is probably under contract to take them, but in this environment they’ll probably tell the shipbuilders to pound sand the next couple years. It’s probably in the interest of the shipbuilders to suck it up as well if they do think CCL can recover – way worse trying to get paid if CCL gets forced into bankruptcy.
  • Credit vs cash refunds- so far, approx. 60% of customers have elected a to receive a future cruise credit rather than cash refund for their postponed cruises – definitely a positive sign for pent up demand

  • Breakeven point- the CCL Q220 earnings call transcript may be worth a read. David Bernstein (CCL CFO and CAO) notes that the breakeven point on an individual ship basis is generally 30-50% of capacity. He estimates that they’d need to run approx. 25 ships for cashflow to breakeven (approx. 25% of fleet). I view this as validation that my analysis is conservative, as I’m anticipating a cash shortfall in 2021 with 50% demand.
  • Debt covenants- I found some of the debt covenant specifics for RCL (net debt to capital ratio, fixed charge coverage ratio, min networth, etc); wasn’t able to find these for CCL and NCLH, but it looks pretty clear that The Big 3 will struggle to meet these. But similar to view on new ship orders, creditors will probably be willing to grant leniency if there is a light at the end of the tunnel – most lenders want to avoid seizure of assets and bankruptcy proceedings.

Other Considerations

  • Bankruptcy- while I definitely see potential upside in an investment in CCL, it is definitely risky. If Covid continues to unfold in a horrific way into 2021, The Big 3 could be pushed into bankruptcies. But important to consider impact to CCL if RCL and/or NCLH go down while it stays afloat. RCL is the 2nd biggest behind CCL – if it files Chapter 11 and is relieved of some of its debt payments, it could suddenly have the opportunity to compete more aggressively. If RCL drives its prices down, it could force CCL to follow, driving CCL into bankruptcy. Takeaway here is that bad news for the other two could ironically lead to bad news for CCL.
  • NCLH differentiation- while NCLH’s balance sheet looked bad going into Covid, two points that I think help its survival case:
    • (1) It historically focused on cruise routes that the other two were not focused on. See snipit from 2019 10-k:

    • (2) its ships are significantly smaller (~30+%) than RCL and CCL. This could come in handy if governments put official caps on the number of people that can be on a cruise at a given time (regardless of ship size).
  • Cruises sailing in 2020analysis assumes no cruises again until 2021, but if some of these carry on (unlikely in the US, but maybe more likely in Europe), it will be very important to track the outcomes and potential regulatory responses.

Bottom line

If betting on the survival and recovery of cruise lines is something that you’re interested in, I think CCL is the best bet. Back in March the market priced death into the Big 3 stock prices, and stock prices of these at the time of this post are not far from those March prices. Applying the lowest PE ratio from the last 10 years (excluding Covid) to this analysis’ EPS estimate shows a sizable ROI is in the cards. By no means should you view this as a real way to project the stock price, but point is that there’s a lot of potential upside here if you can handle the risk.

Caveat emptor. Hope you find this helpful!

Time to Buy Berkshire Hathaway Stock $BRK

I’ve been watching Berskhire Hathaway stock this year — as many investors do. Berkshire’s annual meeting was timed well as it came during the heat of the COVID-19 crisis. Many felt disappointed to hear (or decipher) that Buffett wasn’t leaning in to the downturn. He wasn’t deploying his “war chest” of $125Bn+ in cash. In fact, he sold his airline stakes, sold some banks, and Charlie Munger even mentioned some businesses might be shutdown. Buffett also mentioned that the amount of cash they have isn’t really a lot to them in the grand scheme of a panic.

Now with the S&P back up to near highs, many are calling out Buffett and saying he’s lost his touch. “Maybe he’s too old now” and “maybe he doesn’t care anymore now that he’s approaching 90 and loaded” or “maybe the oracle has lost his touch”.

I don’t really think that’s the case and think the negative sentiment creates an opportunity in Berkshire Hathaway stock. People who argue that Buffett is too old and “lost it” could have easily argued the same thing when he was 65 going on 70, 75 going to 80… Buffett has that itch that can’t be scratched.

I do think some of his methods are too old fashioned. I can’t actually confirm this is true, but he has said he won’t participate in auctions. What board would actually be able to justify selling to him without a second bid? Especially when times are good and they are a good business.

Do we see Buffett do another elephant sized deal? Maybe. Maybe not. As I’ve written before, I think we could see deals that are smaller than what people expect.  But either way, I don’t think the option value of some deal being done is being appropriately valued today.

I’m taking Berkshire Hathaway’s current market cap and subtracting the market values of his equity holdings (note, I pulled this from Bloomberg, so it may not be 100% accurate). I then subtracted the cash to arrive at the value the market is ascribing to the “core Berkshire Hathaway” business.

I say core, but in reality there are so many subsidiaries within Berkshire Hathaway. You have GEICO, Berkshire Hathaway Energy, BNSF, Precision Castparts, just to name a few well known ones. If interested, I highly recommend perusing the list of subsidiaries on Wikipedia. I bet there are quite a few you didn’t realize he owned.

At the end of the day, you’re being asked to pay <8x earnings for the collection of businesses that Warren has acquired AND you have free upside from the cash if it is ever deployed.

Frankly, the real upside in the stock may be 5-10 years away when Berkshire Hathaway is broken up and people realize the sum of the parts is worth more than the whole.

Either way, look at the impact of Berkshire going out and deploying cash. Earnings could likely go up 30% from where they currently are and even deploying the cash at a worse multiple than where Berkshire trades today (i.e. dilutive), you’re still paying <9x earnings.

4 Bank Stocks Worth Considering $WFC $DFS $BNPQY $SNV

Bank stocks have gotten hammered this year. In fact, they only trail energy in terms of worst-performing asset classes.

(thanks Callum Thomas for this chart)

This makes sense. If I were to boil it down in one sentence its “banks do not do well in recessions.”

Borrowers may default on loans and banks use leverage so those defaults add up quickly. In good times, banks also tend to reserve less and take less provisions for loan losses (i.e. losses they generally expect on their portfolios in the future) because its hard for them to see a recession on the horizon – and it also juices net income in the short term.

Then… a recession hits. Banks need to take further provisions and people realizes they may not be invested in a bank that can fully weather a business cycle like they thought.

That’s somewhat true today, but different in a lot of ways as well. Yes, banks so far have taken huge loan losses, major ones detailed below:

They took these provisions because we just so happen to be entering the worst economic crunch anyone reading this has ever seen. I mean, the global economy just ground to a halt. Unemployment has surged. And no one knows how long consumers’ trepidation of traveling, splurging, and so on will last.

At the same time, banks’ balance sheets were essentially forced to be in the strongest position we’ve seen for some time. The last crisis in 2008-2009 was a financial crisis. In response, governments attempted to impose “never again” policies to shore up our financial institutions (arguably, this lowered lending and caused our recovery to be much slower, longer and more painful than it otherwise would have been) and bank stocks were put into the penalty bin.

As you can see below, banks tier 1 capital ratios going into this recession far exceed what they were going into the last recession. While this is a health crisis and not a financial crisis, they still face pain, but should be able to withstand the impacts better.

I think this has created an opportunity in the bank stocks. We can now buy leading franchises below book value and collect meaningful dividends along the way.

Here is a list of banks and financials I am looking at:

You can read my comments for each one above, but I want to very briefly focus on some names I think are worth taking a deeper dive on (frankly, I think the banks in general look cheap and it was very hard to find 4 just to drill into – I think a basket of the above makes a lot of sense, excluding any you don’t want exposure to of course).

Wells Fargo:

This bank is absolutely in the penalty box right now. I mean literally – its in a penalty box. The “fake account” scandal resulted in a freeze on the banks assets as punishment so they could get a handle on what was going on in the firm and improve governance. They are a bank, which requires a lot of trust, and Wells Fargo broke that trust.

How quickly tides turn, though. I remember when Wells Fargo was what JP Morgan is today. The “good” bank. Led by a trustworthy team that wasn’t like those other greedy Wall Street banks. And for that, Wells used to trade at 0.5x-1.0x premium to the group (much like JP Morgan does now). You can clearly see a “changing of the guard” going on here. If you didn’t know when the scandal happened, I am sure you can now pick it out.

But Wells has a new CEO and if you have a long time horizon, I am sure they will figure it out. The CEO, Charles Scharf, has a very interesting pedigree.

  • CEO of Visa from November 2012 to December 2016
  • CEO of JP Morgan’s Retail Financial Services for 9 years (2004-2012)
  • Managing director at One Equity Partners, JPM’s private equity arm
  • CEO & CFO at Bank One in 2000-2002
  • CFO of Corporate and Investment bank at Citigroup (1999-2000)
  • 1995-1999 he was the CFO at Salomon Smith Barney

This guy gets banking. And he’s led some very large firms and divisions.

I understand why Wells Fargo trades at a discount to JPM. It can’t grow. Its brand may be irreparably harmed.

But I doubt that lasts forever. Just like Domino’s improving its pizza brand, a bank can improve too. Recall Soloman Brothers and Bank of America were once hated entities that came back considerably in terms of sentiment and trust.

Time heals all wounds as they say. We just need Wells to survive. Can they do it? Well, again, their capital structure is in healthy shape:

Wells does have exposure to high risk industries, like Oil & Gas and Retail that will be under pressure this year, but it is still very diversified. Also note, when they say retail, that breaks down to other exposures. For example, department stores are only 18% of their total retail exposure, so less than 1.5% of total commercial and industrial loans.

I like Wells Fargo here. I think the dividend is probably maintained so I’m collecting 8% per year to wait. Even if its cut in half, it still would be a 4% dividend (clearly, if they did that things would not be going swimmingly, but over the long run it should even out).


It’s difficult to actually compare Discover to a name like Wells Fargo. Discover is mainly a credit card business (80% of loans), private student loans (~10% of loans) and personal loans (~10%). So if I were to sum up what makes Discover different than the other bank stocks, its that it is more of a bet on the consumer. And these are generally unsecured consumer loans, so they carry risk.

In Q1’2020, Discover increased its reserve ratio for its credit card portfolio to 7.2% (up from 5.9% at the end of 2019) and this is actually somewhat light compared to peers (Synchrony reserved 11%, Capital One reserved 9%, American Express reserved 7%). So there is a risk they need to have additional reserves in 2020. I would say that is the bulk of what people expect and that has people concerned.

On the call, management called out a few things to assuage reserve fears:

To give you a sense for how our card portfolio compares today, with how it looked at the end of 2007, our contingent liability, meaning the total open to buy for our card products has been reduced from roughly 5.7 times loans to around 2.7 times. And the percentage of the portfolio below a FICO score of 660 has gone from 26% at that time, down to 19% at the end of 2019. So, while we are not immune from the impacts of deterioration in the economy our portfolio is significantly better positioned than it was ahead of the last financial crisis.

So the open-to-buy has reduced by about $54 billion from the last recession to this recession. Average FICO scores in the portfolio have increased between 500 and 600 basis points, which is a material change. Our underwriting, frankly, is far more sophisticated than it was 10 years ago. And frankly, the actions that this business undertook when the pandemic started to actually drive some real difficult employment numbers was drastic and very, very quick.

Open-to-buy risk is when a consumer is under financial duress so they draw down on their credit cards. So one, they sap liquidity available and two, they increase the risk because the card lenders’ exposure to riskier credits grows.  It seems as though Discover is in a stronger position today.

Again, if you have a long time horizon, you’re buying a financials that earns a 22%+ ROE for only 1.5x TBV. That seems too cheap to me.

BNP Paribas

And now, for something different again. I actually looked up BNP Paribas, the french bank that is one of the largest in Europe, to see how negative rates would impact the US stocks. Clearly ROAs go down, but BNP’s 5-year average ROE isn’t that bad (the shape of the yield curve matters).

Look, a 8% ROE is not that great. But that is 8% return on book equity… and I can buy BNP right now for 0.4x that book value, so return on MY equity should be much higher in the long run.

Let me show a summary example. Assume a bank has $100 of beginning book value, earns 8% on equity and pays out 40% of its income. In year 10, I sell the bank to 0.4x book value, so I get no benefit from multiple expansion or ROEs improving.

The return on my equity is much more attractive.

Look BNP is like any other bank – it will have issues this year. But BNP is a highly diversified bank and I really like how thorough their management team is – their Q1’2020 investor deck was 84 pages!

BNP right now is planning to pay out 50% of its earnings as a dividend, which will be somewhere between a 9-10% yield on the stock. However, the ECB has told European banks that they need to shore up liquidity to support the economy and to cancel dividends for the time being. Even with the dividend, BNP expects to have a 12% CET1 ratio (about 300bps above the Basel III minimums) so I think that would be a huge boon to be able to pay out its earnings.


Last one I am looking at is a small, southeast US bank called Synovus.  As shown in the table at the beginning of this post, it trades around 0.7x book and has OK, but not great capital buffers. The banks CET1 ratio is 8.7% compared to their goal of 9%. However, new bank accounting standards result in taking higher losses upfront (called CECL), so the management team relayed that CECL reduced CET1 ratios earlier in the cycle. 

As for the downturn, Synovus used to be heavily exposed to commercial real estate, land and 1-4 Family units, but since the crisis has been working to reduce that exposure and get more diversified. 

As  the company noted, because the loss rates of those sectors was so high, this significantly de-risked the company in a stressed scenario. 

We have significantly reduced our exposure to 1-4 family residential, land and investment properties as well as CRE in aggregate. By simply utilizing historical loss rates, the remix of our portfolio alone would result in a 50% reduction in losses. Combined with the improvements in underwriting and portfolio management, we would expect losses to decline even further when evaluating the impact of the severely adverse scenario

Part of the diversification was driven by the banks merger with Florida Community Bank back in 2018. Its funny to look at where Synovus trades now (0.7x BV) compared to when the deal was struck. 

But while merging with a Florida bank diversified the company away from being a mainly Georgian bank, Florida isn’t a great spot to be right now. Tourism drives their economy (Disney World!) and COVID-19 will surely wreak havoc. SNV noted 13% of loans were in deferment, which is pretty high compared to peers and the company noted it was in mostly at risk sectors, probably lining up with this slide:

The good news is that the company said “a lot came in, in the first week or 2. We’ve seen it trail off considerably to the point now where we’re really not adding many deferments to that book. And just want to make sure that we’re clear on it. It’s really just a 90-day program.” So seems like the worst is behind us and hopefully back up in running at quarter end (timing well with a re-opening, I would suspect).

Commercial & Industrial loans make up $17.7BN (or 47% of total exposure):

Within C&I, the specialty divisions such as senior housing and premium finance comprise about 14% of total loans and have been a significant contributor to our growth story while also possessing some of the best credit metrics over the last several years. The overall portfolio is well diversified by industry and geography and is extremely granular with almost 35,000 loans with an average original loan balance of approximately $770,000 

So clearly the bank is exposed to a bunch of smaller sized loans. 

Clearly, SNV is a riskier story, and I would size a position in a portfolio as such, but I think owning Synovus makes sense to buy for a few reasons: 

  • Dividend: Mgmt team seemed committed to the dividend, so we pocket ~7% to wait
  • The bar is already set low – company used to trade above 1.5x book value. I think BV by YE2021 could be ~$30/share, so trading at 1x would be nearly 60% upside plus a HSD dividend
  • Take-out candidate: Any bank that wants to increase its southeastern presence or market share could look to acquire SNV. Float a take-out for 1x TBV and I’m sure the synergies would be large and very accretive for the acquirer (branch consolidation, back office savings, etc).  

All that said, would I buy more Synovus or Wells Fargo or BNP? I’d probably choose the latter two.