NEW YORK (
) -- Consumers love their credit cards, and KBW loves
Alliance Data Systems
KBW analyst Sanjay Sakhrani on Thursday upgraded Alliance Data Systems to "Outperform," with a price target of $149, saying that "fundamental trends are extremely positive for the company given the pro-cyclicality of the three business segments."
ADS focuses on private label card lending through its World Financial Network subsidiary, and also runs loyalty partner programs and through its Epsilon subsidiary, provides a range of customer marketing, database, loyalty management, modeling and other data services.
As we discussed when looking at the February credit card master trust agreements, World Financial Network's private label card portfolios
the competition, when looking at average excess spread, which is a profitability measure showing how much of the portfolio yield is kept by a credit card secrutizer, after netting-out the securities' coupon rate, loan losses and servicing fees.
Sakhrani said that it's not always fair to compare excess spreads, because "during the downturn, some issuers
provided subordination to their trusts, so their excess spreads are inflated by an effective subordination subsidy."
Then again, for Alliance Data Systems' World Financial Network card portfolios, Sakhrani said "there was no subordination," so the card lender's 24.43% annualized excess spread during February was a pure number. World Financial Network's excess spread was the highest among the major U.S. card lenders, despite also having a relatively high net charge-off rate of 5.43% and the highest 30+ days delinquency rate of 4.47%, because of the nature of its private label card business. Private label card portfolios typically see a higher level of revolving debt than bank-branded credit cards, boosting interest revenue.
Here's how World Financial Network's February card numbers compared other major U.S. card lenders:
- Citigroup (C) - Get Report subsidiary Citibank's excess spread on its managed card portfolios during February was 8.23%. The company's net charge-off rate was 5.36% and its 35+ days delinquency rate -- the other card lenders report delinquencies of 30+ days -- was 3.09%.
- For Bank of America (BAC) - Get Report, the February net excess spread for its managed card portfolios was 9.78%. The net charge-off rate for BAC's managed card portfolios was 5.56%. The 30+ days delinquency rate was 3.75%.
- JPMorgan Chase (JPM) - Get Report subsidiary Chase Issuance Trust had a 10.58% excess spread during February, for its managed credit card portfolios. Chase's net charge-off rate for managed card balances was 3.97%, and the 30+ days delinquency rate was 2.42%.
- For Discover Financial Services, the managed card portfolio excess spread during February was 12.66%. Discover's net charge-off rate for its card portfolios was 2.80%, and its 30+ days delinquency rate was 2.25%.
- Capital One's (COF) - Get Report February excess spread was 13.28%. The company's net charge-off rate on managed credit card loan portfolios was 3.20%, and the 30+ days delinquency rate was 3.34%.
- For American Express, the February net excess spread on managed credit card portfolios was 13.30%.. The net charge-off rate was an industry-leading 2.73%, and the 30+ days delinquency rate also led the industry, at just 1.58%.
Alliance Data Systems returned 20% year-to-date, through Wednesday's close at $124.63.
Sakhrani's $149 price target is "derived by applying a 13x multiple to our 2013 EPS estimate of $6.49 from the private label card segment along with an 8x multiple to our 2013 EBITDA/share estimate of $8.11 for the remainder of the company."
The analyst expects Alliance Data Systems to report first-quarter earnings of $2.19 a share, compared to fourth-quarter earnings of $1.70 and first-quarter 2011 EPS of $2.03, on total revenue of $837 million, down slightly from $848 million in the fourth quarter, but increasing 13% year-over-year.
Sakhrani said that "ADS trades at very attractive valuations for its EPS growth rate and economic return profile relative to its peers," especially with a projected 2013 return on tangible equity of "50%+," compared to an estimated 2013 ROTE of 32% for American Express, long the "gold standard" among card lenders. AXP trades for 12 times Sakhrani's 2013 EPS estimate of $4.89.
For private label cards -- representing 50% of company revenue -- Sakhrani said that Alliance Data Systems' "management recently noted that it was seeing sales up 15% yr/yr and portfolio growth of 7% yr/yr in the first quarter and expects 10% yr/yr portfolio growth in 2Q12."
For the company's customer loyalty business, "1Q12, which compares to its long-term growth rate of 5% driven by the return of discretionary spending, strong spend at gas, grocery and pharmacy and promotional work at groceries in Canada," according to Sakhrani.
The analyst added that the Epsilon subsidiary -- which generates roughly 25% of revenue -- "is on track to generate $1 billion in revenues in 2012 with organic growth rates in the high-single-digits range."
Interested in more on Alliance Data Systems? See TheStreet Ratings' report card for this stock.
Written by Philip van Doorn in Jupiter, Fla.
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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.