Analyst Note| Eric Compton, CFA |
No-moat-rated Alliance Data Systems reported a difficult quarter, with net income of $38 million and EPS of $0.81, down roughly 74% and 69%, respectively. Revenue at LoyaltyOne dropped 40%, as Air Miles redeemed fell 42% year over year, which isn’t entirely surprising given the latest travel and rewards spending patterns. This should eventually come back, but it may take more than a year. Card services revenue fell 24% year over year as credit sales fell 36% and normalized card receivables fell 12%. Again, spending patterns are working against ADS as payments volumes and card balances fall, and these will eventually return, but it does highlight the cyclical sensitivity of the business model. There were some expense offsets as operating expenses fell roughly 20%. Management highlighted that roughly 6% of receivables were from retailers who were currently in the bankruptcy process. Once a retailer goes out of business, it typically takes about six months for 50% of the related receivables to roll off, and after about two years only 10% or less of receivables typically remain. In the meantime, profitability on these portfolios typically improves as ADS no longer has to spend on marketing or other compensation agreements, and while this is a short-term benefit, the longer-term loss of receivables and therefore profits is not a positive. This highlights the difficulty that ADS will face as more and more retailers come under pressure, and the difficulties associated with predicting the future profits and size of ADS and therefore the future value of ADS’ shares. Ascena Retail Group just filed for Chapter 11 bankruptcy on July 23, which was another client of ADS, and likely accounted for another 2%-3% of receivables. After incorporating these results into our projections and a 50% chance that Democrat Joe Biden is elected U.S. president and implements his proposed corporate tax hike, we are decreasing our fair value estimate to $59 per share from $62.