Ally Financial: Bright Outlook Ahead, But Is Overvalued (NYSE:ALLY)

Alistair Berg/DigitalVision via Getty Images Ally Financial (NYSE:ALLY) is among the top 25 US banks based on assets and holds a market capitalization of approximately $12.7 billion. As a fully digital bank, Ally has received investments from no one less than the Oracle of Omaha, Warren Buffett, whose company owns 9.5% of the outstanding shares, and is the major shareholder. Nonetheless, when comparing the size of Berkshire’s portfolio, the position is insignificant as it represents less than half of a percent. GuruFocus The stock of Ally is also owned by Bill Nygren, who is known for his value investing style, via his Oakmark Fund. However, he has been slowly trimming his position over the years, while still holding approximately 12 million shares. Finally, at some point, controversial investor and activist George Soros, used to own the stock, but his timing wasn’t the best as he walked away with an approximated loss of -8.42% in Q1 ’22. In this analysis, I will discuss about the current situation of Ally, and decide whether the stock is currently a buy, sell, or hold. Ally’s Stock Performance Data by YCharts Since November, US banks have experienced notable performances, and Ally hasn’t fallen behind. Over the last year, Ally had a total stock performance of 75.09%. Comfortably outperforming the S&P 500 by 23.45% and the Bank Index proxied by the SPDR S&P Bank ETF (KBE) by 43.19%. This heavy upward movement of bank stocks is mainly due to dovish monetary policy expectations that have accumulated for several months, providing stunning performances to bank stocks over the past ten months. Currently, banks are experiencing generally lower net interest income and dovish expectations of rate cuts have brought the market to rise. Nonetheless, at the beginning of the rate hike cycle, the outcome was positive for banks as net interest margins generally expanded due to higher rates on the asset side. However, as time progressed, the banks saw pressure on the liability side as deposits flew to higher-yielding instruments, and as a result, contracting the net interest margin, and subsequently the net interest income, due to significantly higher funding costs. History and Transformation of Ally Financial Many recognize Ally as a digital bank. Nonetheless, before the great financial crisis, they were known as GMAC (General Motors Acceptance Corporation), and in a mission to make strategic movements to the bank, they went fully digital and were rebranded as Ally Financial. From there, the main focus of the bank has been on drastically changing its funding mix. In the past, the bank had a liability structure that relied to a great extent on wholesale funding, which tends to be more expensive and unreliable. But later on, they went heavily into attracting customers’ deposits with the incentive of offering them elevated APYs that were well-aligned with the overnight rate. Ally Presentation As seen in the image above, when Ally went public, 41% of their funding mix was coming from deposits. Yet, several years later, it skyrocketed to a whopping 88% and has stabilized ever since to the point where wholesale funding is minimally utilized. Although the customers’ deposits are not as cheap as money center banks such as Wells Fargo (WFC) or Bank of America (BAC), they are still less inexpensive than wholesale funding and more reliable. Based on their latest filing, in Q2, Ally had approximately $152 billion in total deposits, of which $103 billion came from checking, savings, and money market accounts. While the remaining $49 billion was sourced from certificates of deposit (“CDs”). Meanwhile, the wholesale funding composition was small with approximately $19 billion in debt, representing a composition that stood within their normalized level of 88%. Ally 10-Q As commented, the deposits of Ally aren’t that cheap at 4.21%. For comparison, deposit cost in Q2 for Bank of America was only 2.78%, and this is without weighting $514 billion in non-interest-bearing deposits. Nonetheless, these high-earning accounts have assisted Ally in attracting new customers for years. Customers that enter the Ally ecosystem and are later on cross-sold with extra products such as credit cards, brokerage accounts, personal loans, car loans, home loans, insurance, and others. Although the high interest is perhaps what draws customers’ attention to opening an account with Ally, their digital banking experience offers a great product that could be opened efficiently within a few minutes. Coupled with award-winning customer service and appealing characteristics such as: No maintenance fees. No minimum balance. ATM withdraws reimbursement. Cashback on debit card purchases. Early direct deposits. No overdraft fees. Ally’s presentation Of course, all these benefits negatively affect the profitability of the bank, but they have been essential to bringing the total number of customers depositing to 3.2 million. These customers not only help to have cheap and reliable sources of funding but out of those, currently 10% of them moved forward and started an extra relationship on either their investing platform, home loan, or credit card. Ally is Ready to Benefit From Rate Cuts The current situation of Ally is similar to most of the banks. Initially, rate hikes helped them, but later one, affected them as funding pressure started to be higher than the marginal increase in asset yield gain. 2Q 24 2Q 23 2Q 22 Net interest margin 3.27% 3.38% 4.04% Net Charge-off rate 1.26% 1.16% 0.49% Efficiency Ratio 64.30% 60.10% 54.80% Click to enlarge Source: Ally’s Financial Supplements As seen in the table above, Ally has decreased its net interest margin for the past two years, in addition to increasing its net charge-off and efficiency ratio. Nonetheless, Ally recently saw a slight quarter-over-quarter improvement in these metrics. For example, in Q2, the NIM saw a slight improvement and sat higher at 3.27% compared to the 3.13% figure exhibited in the initial three months of the year. Currently, there might be many retail customers who perhaps do not renovate their car because interest rates are too high, and therefore they would rather wait for the situation to normalize. These personas, who match the bank’s risk profile, might boost Ally’s ability to initiate loans, benefiting its top line once rates begin dropping. A market confirmation of this came in the keynote that FED Chair Jerome Powell had at Jackson Hole, where he expressed that the time has come for policy to be adjusted. This statement made many investors go more bullish on the stock, as they knew this event would most likely benefit the bank, and as a result, Ally’s stock price jumped 4.03% on that trading day. Takeaway: Why I Am Not Bullish Even With The Backdrop Ally is a company that has a positive outlook due to the imminent cuts in interest rates. On top of that, they had a great performance, both in strategy implementation and stock price, over the past year. Nonetheless, their current valuation is not as attractive for one to be screaming bullishness in the stock. For example, their return on equity is 6.28%. But if it is considered that their cost of equity is higher at 8.3% based on CAPM, the stock does not have a justification to be trading above book value, but it is. Currently, Ally has a PB of 1.10x, suggesting that the stock is overvalued. Data by YCharts This conclusion is consistent with the average price-to-tangible book value of Ally, which sits at approximately 17.2% higher than the five-year average. Although this might be an appropriate timing for the financials of Ally to improve, perhaps the market already discounted this a long time ago and is not appropriate to initiate a position on the stock. Ultimately, the share price of a company reverts to its fundamentals, and in this case, it’s rather a more reasonable idea to set an alert on Ally’s stock once the price drops than to enter a stock without a margin of safety, as it is overvalued. Therefore, I downgrade my previous buy rating on Ally to a hold.

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