Thesis

Ally Financial Inc. (NYSE: ALLY) has continued to underperform the SPDR S&P 500 ETF (SPY) over the past month since we launched our Hold rating. The lender was battered by macro headwinds, and higher provisions for credit losses as post-pandemic credit trends normalize further. In addition, continued headwinds seen in the used car market have also shaken investor confidence in ALLY as the used car value index is down month-over-month at mid-August.

However, we also noted that ALLY could have reached its mid-term low at the end of July after the publication of its second quarter results. Given the knocks ALLY has taken since its October 2021 highs (down 44% from its July lows), we are confident about its July low as its valuation is also attractive.

Therefore, we are revising our rating on ALLY from Hold to Buy.

The blows to ALLY are justified

Ally reported consumer auto designs of $13.3 billion in the second quarter, as it hit a new record for builds, despite a weak auto market in the second quarter. Therefore, it demonstrated that the trend of the company’s automobile creations remains robust, although it has further normalized.

As noted above, creations grew only 2.8% year-on-year in Q2, compared to 13.7% in Q1. This is another quarter of below-trend growth as Ally breaks some very tough comps from 2021. Additionally, the Manheim Index suggests another weak month in mid-August, as it fell to 211.6, down another 2% from July. Accordingly, we expect headwinds in the automotive market to continue to impact Ally’s auto emissions growth pace in the near term as economic headwinds intensify. CEO Jeff Brown emphasized:

Our ability to generate strong consumer inquiries shows the breadth of our automotive business and the depth of the application stream. Supply chain challenges persist and demand remains robust, leading to low inventory levels and therefore support for used vehicle values. In general, macroeconomic uncertainty and market volatility are high. [These] unique challenges are likely to continue in the coming quarters. (Call on Ally FQ2’22 results)

But, things should get better for Ally from here.

Consensus (bullish) estimates suggest Ally’s underlying metrics should improve from here. Notably, we should see Ally’s Adjusted EPS growth bottoming out in Q2, as it recorded a provision for credit losses of $304M in Q2, up significantly from $167M in Q1.

Moreover, the guided direction did not observe a significant deterioration in the evolution of credit in a framework of normalization. Therefore, if the macros improve further in the future, we are confident that this could help lift Ally’s earnings from their nadir.

In addition, management also indicated that it was increasing its returns in several verticals beyond auto finance, which should underpin its earnings recovery. Chief Financial Officer Jenn LaClair said:

We see plenty of opportunities to continue to see expansion in yields. We develop our unsecured portfolios, Ally Lending, Credit Card. We’re seeing really robust origination returns in the lower teens for Ally Lending and the upper teens for credit cards, and we’re growing them very quickly and seeing a trajectory of $4 billion to $6 billion in those wallets. Corporate finance continues to grow. We hit a high of $8.5 billion in HFI this quarter, continuing to see a clear path to around $10 billion and rising returns from there. (Allied Revenue)

ALLY valuations are attractive

ALLY last traded at an NTM Normalized P/E of 5.04x. At its July lows, its valuation hit levels more than two standard deviations below its 5-year average. Although it has recovered from its July lows, we believe ALLY’s valuation remains attractive as its EPS growth is expected to improve in FY23. Accordingly, we are confident that we have probably saw the troughs in its medium-term valuation in July.

Is ALLY stock a buy, sell or hold?

As seen above, ALLY’s price action has solidly consolidated from its June and July lows. With July’s long-term trough process, we postulate that the moves from its October highs appear complete.

Consequently, ALLY’s price action is constructive, which bodes well for its attractive valuation, as noted earlier.

Consequently, we are revising our rating on ALLY from Hold to Buy.