Why You Should Get To Know This Under-the-Radar Fintech Stock

Alliance Data Systems (NYSE:ADS) may not be a household name, but there’s a good chance you use one of their credit cards. The company provides private-label credit card services for retailers and other well-known brands.

In this episode of “Beat and Raise,” recorded on Jan. 27Fool contributors Jason Hall and Brian Withers discuss Alliance Data Systems’ latest report and why the stock has a bright future in front of it.

Jason Hall: Let’s talk about Alliance Data Systems. What do you say Brian?

Brian Withers: yeah. What the heck do these guys do?

Jason Hall: It’s a really interesting company. You go back like a long time ago, you go back to the mid-’90s. JCPenney’s credit card processing business, and The Limited’s credit card bank. The Limited owned a bank like back in the ’90s, tons of retailers actually owned banks that did personal finance. Those two banks merged or those two businesses that were part of retailers merged and they became Alliance Data Systems and then a few years after that, they bought LoyaltyOne, which was like the loyalty program manager for airlines is the big thing that LoyaltyOne does. They bought something called Epsilon, which I don’t really know much about, to be honest with you.

But fast-forward until a couple of years ago and things just weren’t really going well, it wasn’t managed well. The board made a strategic decision. Let’s spin-off some of these other things and let’s focus on our core business. That core business is private-label credit cards or rewards programs too. Those two things that they do so maybe you have a credit card that has Toyota (NYSE:TM) is one they just signed. They manage the Toyota program. The NFL, they just announced this in December, they’re going to be the company that manages the NFL’s credit card, so you have your favorite team and the logo when you get rewards that you can spend on NFL merchandise and all that stuff, so they are the company behind a lot of that so it’s a really interesting business.

Brian Withers: It’s like a fintech.

Jason Hall: It’s very much a fintech. They bought a company called Bread. Not to be confused with Toast (NYSE:TOST). [laughs] They are very much getting more into fintech financial services. Fintech is an interesting term but I think just more broadly fintech is part of financial services, that’s what they do. Anyway, they just spun out Alliance One during the fiscal year. That’s good so some good things that came out of that I’ll go ahead and pull up the screen share here.

It’s streamlined the business No. 1, but it’s also tightened up the balance sheet. Since I mentioned, I’ll bring it up. That happened in the prior quarter in the third quarter, in the fourth quarter $750 million of debt has been paid off and goodwill because of all the various and sundry acquisitions over the years, because of that spin-off, $700 million in goodwill went with one of those acquisitions.

The balance sheet is better. That’s really important for this kind of business, as they manage their balance sheet manage their debt is to make sure that it’s clean so as they get more debt in a rising interest rate environment they want to manage that expense, so it’s a really good thing .

How did they do? First of all, you’ll see in parentheses next to quarterly results up there I have continuing operations. That’s because they sold off a large part of their operation in the year, and over the next several quarters until they fully lap that, they’re going to report results from continuing operations against results from continuing operations. They are excluding that LoyaltyOne business from last year’s numbers, so you have a comparable comparison when you’re looking at last year versus this year. Are you with me so far?

Brian Withers: Yes.

Jason Hall: Revenue came in at $855 million. That was up 11%. That core business is really good, 15% increase in credit sales. Some good things are happening in that core business. It was a miss the expectation was for over a billion dollars. Again that’s not management’s guidance, but that was the expectations coming from Wall Street analysts that cover the business.

It’s still complex with everything with the spin-off of the business. I think it might take some time for analysts to get their modeling right to really be close. I don’t really consider this a miss as much as analysts miss. I don’t think the company missed. Earnings per share was down 21%. There’s a number of reasons for that. Costs are going up because they are investing in this core business, they’re spending money, they’re hiring people, marketing. They’re really making an effort to make a big push to go after more clients. Also, they took some and of course, the word just fell out of my head. But they’ve taken some actions on their balance sheet because credit defaults and delinquencies are going up.

We’re coming out of this period of a federal stimulus and all of those things which we’ve seen delinquency rates, and we’ve seen credit losses like they’re at some of the lowest levels ever. But we’re starting to see them creep back up. They are taking some actions to bolster the balance sheet to prepare for that and that had an impact on earnings. That was a big reason why earnings missed.

Again I talked about credit sales were up 15% but one of the things they said that it’s just really positive is that they’ve basically got almost all of their partnerships that generate their revenues are basically locked up through 2023. They have some that aren it, for example, Ulta Beauty (NASDAQ:ULTA), that’s one of their biggest customers and it’s a long-term customer. They just signed a long term, they announced that maybe two or three weeks ago, maybe a month ago now, that they had resigned an extension to that deal with Ulta Beauty.

New customer Toyota and Lexus I believe that’s the Toyota subsidiary the premium brand, so they just signed Toyota. Again I mentioned in the National Football League that’s a pretty big get because it’s very visible, and there are lots of NFL fans. Sports fans spend money and they like things that show their loyalty to their teams. That’s a really interesting thing. TBC Corporation [part of Sumitomo Corporation (OTC:SSUM.Y) and Michelin (OTC:MGDDY)], you’ve heard of National Tire and Battery, Big O Tires, Midas. This is the company that owns all of those auto repair retailers and tire sellers, which is really interesting. TBC Corporation as an aside is actually owned by Sumitomo and Michelin. Two of the biggest tire companies in the world. It’s a joint venture to own all of these US-based tire sellers and auto repair companies. Anyway, they signed those up that’s again another large retail footprint, lots of visibility there.

The balance sheet’s stronger, the stock’s really taken a beating. It’s been caught up in a lot of the same thing we’ve seen with a lot of growth stocks, a lot of fintech stocks. It’s interesting because Brian this isn’t necessarily like one of those 30, 40, 50% per year growth companies, we’ve seen a lot that have taken a beating. This isn’t a company that’s reporting GAAP losses. This is a profitable business, and it’s a business that anticipates they will probably grow low double-digit revenues like 10, 12% revenue growth will be pretty good. Because of operating leverage they can get better earnings growth out of that which is good, I think it’s really attractive. The one concern, it’s consumer credit.

Brian Withers: right.

Jason Hall: It’s unsecured consumer credit, that’s the riskier place to be involved. Because of the structure of a lot of their deals, credit losses can hit their books, it’s a reality and a thing to have to concern. Those rates are starting to go up, but the CEO did point out that they’re still well below long-term levels, and they expected 2022 should be fine in that regard even though they increase a little bit. That’s basically it.

Brian Withers: I see you got little D circles which means dividend, and they’ve been a pretty steady dividend raise company.

Jason Hall: yeah. The yield’s low. The yield’s maybe a .50% or somewhere around there, less than 1%. It’s just a little less than 1%, but it’s easy to miss the sneaky returns you can get from a dividend like that over time when they compound it and grow it every year and increase it over time. My guess is because of the nature of this business and that it’s already at a pretty good critical mass, is that they probably will continue to try to increase that dividend over time.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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