Markets don’t like instability, investors shy away from uncertainty, and consumer confidence goes down in difficult times.
– Richard Quest
Imagine owning a retail loyalty business at a time when consumer confidence is down in the dumps, a credit card business at a time when the real unemployment rate is high, and an air miles business at a time when airlines are leaking cash and are desperate for travel to restart.
That, in short, is the story of Alliance Data Systems (ADS) in COVID-19 times. The stock is currently at $47, as of August 13, 2020, a pale shadow of its 2015 high of about $310.
Many investors have begun taking a liking to beaten-down pre-COVID-19 themes, and it is a matter of time before sentiment starts favoring ADS too. Nonetheless, one needs to check if it qualifies for investment as of now.
The Stimulus Factor
In Q2 2020, ADS beat EPS estimates by $0.34 but missed revenue estimates by $178 million. The primary reason was the stimulus checks, and the secondary reason was that many states had reopened for business. People had cash, and they paid up their dues, and delinquency rates stabilized or reduced.
(Image Source: ADS Q2 2020 Earnings Call Transcript)
However, things have taken a turn for the worse since then, and the virus is back with a vengeance. Schools are opening in an unplanned manner, people are not obeying the mask orders, election rhetoric is getting shriller, eviction notices are being printed, and politicians have taken a break without agreeing on the Stimulus-2 bill.
Everything seems to be in a mess these days, and the virus is not letting up. Bankruptcies have started surging, and the retail and airline industries are facing rough weather. Therefore ADS’ business prospects seem uncertain until an effective and safe vaccine, or a drug, is developed for COVID-19.
Return on Money Deployed in Business
(Image Source: ADS’s Q2 2020 SEC Filing)
ADS’s balance sheet has about $16.6 billion in deposits, long-term debt, paid-in capital, retained earnings, and non-recourse borrowings. It is reasonable to estimate that by deploying this capital in the business, the company should earn a reasonable return and generate healthy cash flows.
In Q2 2020, ADS generated $495 million in operating cash flows after providing for a non-cash charge of $304.3 million. The company’s operating income in the same quarter was $174.7 million. That means the company generated 2.98% and 1.05% of its total money employed in the business as quarterly operating cash flows and net income, respectively.
The outlook is uncertain, and Q3 and Q4 2020 may not be as decent as H1 2020. Therefore, ADS’s earning power in the short term may be adversely impacted.
Total Return amongst Peers
(Image Source: Seeking Alpha)
ADS’s Total Return metric compares poorly with that of its peers like Seagate Technology (STX), Citrix Systems (CTXS), and Axcelis Technologies (ACLS). The peers have delivered superior returns or have not lost much on multiple time frames ranging between 1 year and 10 years.
ADS compares favorably only from the very short-term point of view (1 month), but it has been a loser on every other time frame.
ADS is a beaten-down stock and it can rise in the short term, especially if market operators start paying attention to names that got hammered because of the pandemic. It looks like a trading idea that is dependent on charts rather than fundamentals.
If I were a long-term investor, I would keep away from ADS because the unemployment situation can linger on till 2022. The retail industry is floundering, the airline industry hopes to recover by 2024, and there’s a wave of bankruptcies coming up. The outlook is uncertain, and the company is slashing expenses to ride through this rough patch. So long COVID-19 hangs around, the company will likely feel the pain.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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