My inaugural analysis on Seeking Alpha covered OneMain Holdings (NYSE:OMF), a personal lender in the subprime market (which they call nonprime). In my thesis, I differentiated their economic model from the practices that precipitated the 2008 financial crisis and noted how their risk model allows them to make loans with good credit quality among these low-scoring borrowers.
Shortly after, the price of OMF skyrocketed and almost exceeded $50. After hovering in the upper $40s for the past two months, shares fell again to the low $40s following the release of fourth-quarter 2023 results last week. Yet I think the market is once again failing to appreciate the true value of this company, even under conservative assumptions. That’s why I’m going to review the fourth quarter results, address a few other questions, and once again explain why OMF is a BUY.
To make things a little simpler, I’ll rephrase some of my key points on why OMF was a buy:
- Subprime borrowers are underserved, giving OneMain their pick.
- Customer data with deep histories gives them a sophisticated risk model.
- OMF prefers capital preservation and return on equity over growth.
- Current prices provide a high dividend yield and make buybacks efficient.
Now let’s look at what’s new.
Q4 and FY2023
Lending slowed as the company continued its credit tightening process. This does not mean that the company has been idle with its capital. In late November, shortly after my first article, the company announced that it acquisition of Foursight Capital. (This will be crucial for their automatic funding line, which I’ll talk about later.)
Additionally, it repurchased 531,000 common shares for $20 million (see the publication of the results). This averages out to a price of approximately $37.66 per share, a timely price and well below the higher prices during this period.
The Front Book, which accounts for loans subject to the stricter origination standards the company has begun to adopt, now represents 65% of the loan portfolio. Unpaid debts have increased, but they remain concentrated in the decreasing Back Book, and the company remains very profitable.
When asked about slowing growth during the fourth quarter earnings call, CEO Doug Shulman explained:
I have said it many times: growth is an outcome. We’re going to make sure we close deals with customers who we believe can be successful, meaning they pay us back and maintain good credit. And we’re going to err on the side of caution.
Capital generation in 2023 (OneMain’s measure of real profits) was $794 million. Although lower than previous years, profitability remains strong. This was accompanied by growth in receivables to $22.2 billion.
It was also a significant year for the company in raising capital, with two bonds issued, due 2029 and 2030, providing $1.1 billion to the company. Mr. Shulman also noted that this funding was possible because of their distinct reputation from previous years:
What I would say is that since 2021 and early 2022, there was a ton of supply in the market, and there was a lot of irrational pricing, which meant people were giving loans to people with high expectations of losses at 10%, which just didn’t make sense, and people lost a lot of money when that happened. In 2022, early 23, many of our competitors simply couldn’t get financing. So we had a fairly wide open market.
Overall, even though it wasn’t the most profitable year ever, there was still evidence that OneMain is running a great business. 2023 allowed them to make money and position themselves for a better future, while other lenders took losses and missed opportunities.
Foursight and BrightWay
Although personal loans are OneMain’s core business, they may expand into auto financing and credit cards. This is where their nascent business segments will be crucial for growth. Since both really took off this quarter and weren’t mentioned in my last article, I want to discuss them now.
In the press release I linked to earlier, Shulman said of Foursight:
Foursight is an attractive add-on acquisition that provides us with a seasoned team, scalable technology, tested credit models, a franchised dealer network and a high-quality loan portfolio to support our disciplined expansion into the auto lending industry.
So it didn’t just add strengths to their book. This is something that will allow them to take the advantages of their current model and synergize it with the access it gives them to the auto loan market.
I want to come back again to another presentation the company gave last fall, and I’ve cropped the slide above for convenience. They already have an auto loan line dating back to 2014. You’ll see here that the APR on these loans is slightly lower than OneMain’s portfolio average, but the DQ rate and net charge-offs are significantly lower over time. Through its dealer networks and other advantages, I believe Foursight will allow them to develop this more secure form of lending over time.
Foursight happened after my last article. BrightWay, OneMain’s line of credit cards, was already in the works before this. The company has spent the last year testing the product with small groups and collecting customer data to identify necessary risk factors. The slide above shows that they headed into serious expansion in the fourth quarter, with BrightWay’s receivables increasing from $98 million to $330 million.
As a digital and mobile business, I believe this will not only give OneMain access to a wider range of customers, but I believe the mobile app has the potential to be a primary source of new customers in the future.
Together, the two lines provide the company with profitable growth paths over time in broader markets.
I want to review my previous valuation, which I did with my EPS estimate going forward, connected to a discounted cash flow model.
The 3% growth in EPS is based on:
- A steady rise in receivables, as has happened consistently
- Regular repurchases as the company recently adopted
- Consistent profits make both of these things possible
The final multiple of 5 was also intended to keep the valuation conservative, since OneMain still trades at a low multiple, and a subprime lender like this can often be vulnerable to bouts of pessimism in a public market.
I don’t think enough has changed in the last quarter that I need to update my calculation. My EPS came from an assumed profit of $750 million, while the company reported $794 million in capital generated for 2023. I also didn’t factor in the possibility of acquisitions growing the business by favorably (we have yet to see how much Foursight will grow its annual earnings). ). Still, Shulman made it clear that while they are preparing for growth when the time comes, their approach for now is slower and steadier.
So while I’m sticking with my fair value of $60.51 for now, these details reinforce my contention that this is a modest valuation and that OMF stock is trading at an attractive discount in modest assumptions.
I don’t assume growth in the 10% range, because we can’t be sure how long interest rates will remain high and how long inflation will need to be kept in check. Given this, OneMain will focus on capital preservation for the foreseeable future and expand only where it perceives no danger. This is what makes them so attractive: a discount even for the safe. Everywhere I look, I’m hard-pressed to find stocks priced like this (which I suppose is how they should be).
Although they run the business very conservatively, let’s talk about the potential risks here. Shulman provided more light on its internal risk model in fourth-quarter results:
But at the moment we have a macro-overlay of one 30% additional stress. So, all things being equal, we’re basically saying we’ll only book deals if credit gets 30% worse than we think, because we want to be conservative. I think what we’ll see depends: we’ll see payments come in, we’ll see credit results, we’ll see what happens with our weather vein. And we’ll also see what’s happening externally with the macro. What happens to jobs, what happens to inflation or interest rates falling and our citizens spending more? There’s the whole external macroeconomics… when you read the newspapers and you watch CNBC, everyone thinks the economy is great. It’s not so good for everyone in the country and the less money you have, the tighter it is for you.
Even though we don’t know the ins and outs of their risk model (a trade secret), we see that they give themselves some sort of margin of safety with the current book. So anything that would be a surprise to management would also be a surprise to shareholders. Something that could have an unusually and historically negative impact on the economy would have a greater impact on OneMain’s customer than other lenders.
Premature rate cuts could again lead to additional inflation that squeezes the budgets of non-prime borrowers. Second, there is concerns about a commercial real estate crash could have a ripple effect on financial markets, indirectly devastating non-prime borrowers. OMF owners should be sensitive to these kinds of setbacks.
Although no major changes occurred in the fourth quarter, we finally got results for fiscal 2023 and (most importantly) we finally saw the seeds of OneMain’s future being planted: self-funding and cards credit. By leveraging the expertise of its core business in personal loans, OneMain will be able to grow its high-yield loan portfolio as it enters these markets on favorable terms.
The risks aren’t zero, but the company has a conservative underwriting posture, and the price of OMF itself removes much of the risk, trading at a discount even for a modest valuation. For these reasons, I still consider this a solid BUY for the long-term investor.