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GE's Synchrony IPO a Safe Bet on Big Box Retail Recovery

NEW YORK (TheStreet) -- General Electric's (GE) initial public offering of its consumer lending arm, Synchrony Financial (SYF), is in many ways a bet on the sustainability of big box retail, which continues to suffer from a cash-strapped consumer and the death of the American mall. Synchrony Financial may be the safest way to invest in a retail recovery as the company's key partners like J.C. Penney (JCP - Get Report), Walmart (WMT) and Gap  (GPS) continue to struggle with weak growth.

The GE-owned company plays in perhaps the most profitable part of the struggling world of big box retail. Synchrony Financial provides private label credit cards to large retailers across the U.S. and its customers can be seen as some of the most loyal shoppers left in the retail universe. Synchrony's average customer has had their branded credit card for 7.7 years, and the average customer made over a dozen purchases per retail credit card.

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Synchrony's average customer also appears to be in a relatively sound financial position. The company's average customer account had a FICO score of 710, and total loan receivables had a weighted average FICO score of 694. Over 70% of those total loan receivables were with accounts carrying a prime FICO score.

That loyalty and financial standing makes Synchrony's average customer highly coveted by its retail partners. Synchrony's top five partners, Walmart, Sams' Club, Lowe's (LOW), J.C. Penney and Gap, accounted for over 48% of the company's 2013 revenue and 19 retailers accounted for 95.3% of annual sales.

If sales growth at retailers like Walmart, J.C. Penney and Gap is very much in question, Synchrony, by contrast, appears to have strong sales visibility.

"Synchrony Financial has relatively strong revenue visibility due to its stable customer base and strong risk management, which helped it to be profitable throughout the financial crisis," notes BTIG analyst Mark Palmer.

Meanwhile, anyone watching the banking sector in recent years has seen that credit quality continues to improve. Synchrony may see an outsized benefit from a continued recovery in the financial health of the U.S. consumer when compared against retailers. Recovering consumers would, at once, improve Synchrony's credit expense and potentially also boost overall purchase volumes.

Valuation, however, presents a challenge for potential Synchrony investors. The company priced its IPO at the low-end of its range. On one of the worst days for stock markets in 2014, Synchrony closed at its IPO price of $23 a share.

BTIG's Palmer believes Synchrony shares could rise to $30 based on his forecast that the company could earn $2.52 a share by 2016 vs. the $2.21 a share in EPS the company earned in 2013. Palmer's $30-a-share price target, however, hinges on Synchrony achieving a price of 12 times 2016 earnings per share, a premium to competitors such as Discover Financial Services (DFS). Currently Discover trades at 10.4 times forecast 2016 EPS, while American Express (AXP) trades at 13.6 times 2016 EPS.

GE will continue to hold a majority stake in Synchrony Financial into 2015, the company has said. Next year, GE plans split off its ownership of Synchrony through either a tax-free distribution of shares or other methods.

As part of GE's exit, Synchrony will repay $8.1 billion in debt it owes to GE Capital and incur $1.5 billion in related-party debt under a new term loan. Overall, BTIG's Palmer expects that Synchrony will incur up to $400 million in added expense to operate as an independent company, including an up to $100 million increase in advertising expense to build brand awareness.

Bottom Line: As GE exits Synchrony Financial, the company's financial prospects as a standalone will become more apparent to shareholders. The former GE-arm looks like a compelling way to play a recovery for retailers and the U.S. consumer.

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-- Written by Antoine Gara in New York

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