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A very cheap fast-grower

This month’s winner was Bayer, which rose 16 percent on rumours of an impending settlement in the Roundup case. The loser was Alliance Data Systems (ADS), so let me take the opportunity to say a little more about this company.

ADS has two businesses: loyalty programs (10 percent of profits) and private label credit cards (90 percent of profits). The former is a stable service in which customers collect points that they can then redeem for goods and services, but it is not growing. ADS is likely to sell this arm within a year.

The other business, credit cards, is the important one. ADS handles complete membership and credit card activities for retail chains. Its customers are both online and offline and include well-known companies such as Ikea and Victoria’s Secret. The online segment is growing faster today than the offline is segment is shrinking.

What appeals to me about the company is that, despite good credit scores, it charges high interest on its lending. The reason is that the cardholders get big discounts from retailers, making the overall deal a good one. The company has therefore been able to generate an average return on equity of over 30 percent in recent years.

Credit and retail? Don’t I know where we are in the cycle? At first glance, ADS looks like it would be the first victim of any future recession, but the reality is different. Although credit volumes will probably fall somewhat, I find it hard to see that it will lose money. Its customers have high credit scores (prime), and the outstanding balance per customer is small (USD 600-700 compared with USD 9,000 for regular credit cards). In fact, ADS’s profit was unchanged during the financial crisis of 2007-2009.

ADS is today valued at approximately 7 times earnings, while giving a direct yield (in the form of buybacks) of almost 6 percent. This is very cheap for a company that I believe will grow by over 5 percent per year over the next 5-10 years.

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