Alliance Data Systems Stock Has Growth Potential Once Consumer Spending Recovers

We believe that Alliance Data Systems stock (NYSE: ADS) has an upside potential of 60% over the next 1-2 years, when the user transaction volumes return to the pre-crisis levels. ADS trades near $52 currently and it has lost 54% in value year-to-date. It traded at a pre-Covid high of $101 in February and is 49% below that level now. Also, ADS stock has gained 66% from the lows of $31 seen in March 2020, after the multi-billion dollar stimulus package announced by the U.S. government, which helped the stock market recover to a large extent. The stock is leading the broader markets (S&P 500 is up about 45%), as investors are positive about the recovery in consumer demand to the pre-Covid levels. Alliance Data Systems is the engine behind loyalty and marketing campaigns for consumer-facing companies and mainly relies on user transaction data. The user transaction volumes suffered in the first three quarters as a result of the lower consumer demand due to the Covid-19 pandemic. This was also the main reason behind the 27% y-o-y drop in ADS’ Q3 revenues. However, lockdown restrictions have been eased in most places and the economy is inching towards normalcy. The same is evident from the month-on-month growth in the U.S consumer spending over the recent months. Despite some growth in the stock since late March, we believe that the stock has room for growth in the near future provided there is no sudden uptick in the Covid-19 cases leading to further lockdown restrictions. Our conclusion is based on our detailed analysis of Alliance Data Systems’ stock performance during the current crisis with that during the 2008 recession in an interactive dashboard analysis.

2020 Coronavirus Crisis

• 12/12/2019: Coronavirus cases first reported in China
• 1/31/2020: WHO declares a global health emergency.
• 2/19/2020: Signs of effective containment in China and hopes of monetary easing by major central banks helps S&P 500 reach a record high
• 3/23/2020: S&P 500 drops 34% from the peak level seen on Feb 19, as Covid-19 cases accelerate outside China. Doesn’t help that oil prices crash in mid-March amid Saudi-led price war
• From 3/24/2020: S&P 500 recovers 46% from the lows seen on Mar 23, as the Fed’s multi-billion dollar stimulus package suppresses near-term survival anxiety and infuses liquidity into the system.

In contrast, here’s how ADS and the broader market performed during the 2007/2008 crisis.

Timeline of 2007-08 Crisis

• 10/1/2007: Approximate pre-crisis peak in the S&P 500 index
• 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
• 3/1/2009: Approximate bottoming out of the S&P 500 index
• 1/1/2010: Initial recovery to levels before the accelerated decline (around 9/1/2008)

Alliance Data Systems vs S&P 500 Performance Over 2007-08 Financial Crisis

ADS stock declined from levels of around $77 in October 2007 (the pre-crisis peak) to roughly $30 in March 2009 (as the markets bottomed out), implying that the stock lost as much as 62% of its value from its approximate pre-crisis peak. This marked a sharper drop than the broader S&P, which fell by about 51%.

However, ADS recovered strongly post the 2008 crisis to about $65 in early 2010 – rising by 118% between March 2009 and January 2010. In comparison, the S&P bounced back by about 48% over the same period. 

Alliance Data Systems’ Fundamentals in Recent Years Look Strong

Note: – ADS sold its Epsilon business in 2019. We have removed the segment revenues from the prior year’s total revenue figures for ease of comparison.

Alliance Data Systems revenues saw a rise of 29% from $4.3 billion in 2015 to $5.6 billion in 2019, mainly driven by growth in the card services segment. However, the company’s net income decreased from $596.5 million to $278 million, resulting in an EPS drop from $8.91 in 2015 to $5.36 in 2019. The main reason behind this drop was a loss from discontinued operations due to the after-tax loss on the sale of Epsilon. Further, the company’s Q3 2020 revenues were 27% below the year-ago period.

Does Alliance Data Systems Have A Sufficient Cash Cushion To Meet Its Obligations Through The Coronavirus Crisis?

Alliance Data Systems’ total debt decreased from $5.6 billion in 2016 to $2.8 billion at the end of Q3 2020, while its total cash increased from $1.9 billion to around $3.1 billion over the same period. The company also generated $1.5 billion in cash from its operations in the first nine months of 2020, and it appears to be in a good position to weather the crisis.

CONCLUSION

Phases of Covid-19 crisis:

• Early- to mid-March 2020: Fear of the coronavirus outbreak spreading rapidly translates into reality, with the number of cases accelerating globally
• Late-March 2020 onward: Social distancing measures + lockdowns
• April 2020: Fed stimulus suppresses near-term survival anxiety
• May-June 2020: Recovery of demand, with the gradual lifting of lockdowns – no panic anymore despite a steady increase in the number of cases
• July-October 2020: Poor Q2 results and lukewarm Q3 expectations, but continued improvement in demand, a decline in the number of new cases, and progress with vaccine development buoy market sentiment

Keeping in mind the trajectory over 2009-10 and given the improvement in Alliance Data Systems’ stock since late March, this suggests a potential recovery to around $84 (63% upside) once economic conditions begin to show signs of improving. This marks a partial recovery to the $101 level Alliance Data Systems’ stock was at before the coronavirus outbreak gained global momentum.

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