OneMain Holdings: A Cheap Stock With An Overlooked Potential

Stock Market

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As the adage goes, “with great risk comes even greater reward,” I believe this is the underlying philosophy that describes the prospects of OneMain Holdings, Inc. (NYSE:OMF). However, there is one key point of difference that is critical. OMF has positioned itself to capture the ‘greater reward’, yet has systematically minimized its risk exposure through a smart business strategy. This is precisely why I find the stock to be a buy.

Company Overview

OneMain Holdings is the parent company of OneMain Finance Corporation (OMFC), which, as its wholly-owned direct subsidiary, acts as the company’s issuing entity of its outstanding public debt. The company is essentially a customer-oriented financial service that has a business model based on providing loans to individuals with relatively lower credit scores at high-interest margins.

The company is defined by the responsible packages it offers to non-prime customers through a range of wellness programs, which guide them to improve their financial positions. An example of the company implementing this strategy was its acquisition of the financial wellness fintech platform, Trim, in April 2021. This points to the broader strategic approach undertaken by the company to pour resources into such digital investments that would enable the optimization of its customers’ spending behaviors.

In addition to personal loan services to non-prime customers, OneMain also offers its credit cards, BrightWay and BrightWay+, launched in 2021. With its strategic initiatives and value-adding acquisitions, OMF certainly appears to be on a path toward a stellar growth trajectory. However, recent inflationary pressures and interest rate hikes have dealt a significant blow to the entire credit services industry, with no clarity as to how long this phase may last.

Industrial Overview & Potential For OMF

The recent circumstances that have brought about a spiral to the wider equity markets have laid an impact on the stock price of OMF throughout the prior year. This is indicated in the stock comparison below, highlighting OMF’s movements with that of the S&P 500:

price chart

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As can be observed, OMF has predominantly given rise to steeper returns as opposed to the S&P 500, which is understandable, given the riskier nature of the company’s business approach, which leads to greater climbs. However, due to this aspect of the company, its falls too are far steeper than those of the wider market. This is glaringly obvious in the Covid-19 dip in early 2020. A similar plummet has been seen more recently, with OMF dropping to a low of $40.25 on 11 May 2022, which was its lowest stock price in 18 months.

The pessimism amongst market players comes as no surprise, given that non-prime borrowers are expected to be some of the most impacted in the present inflationary climate. This is largely due to the increased daily costs coupled with a substantially higher cost of borrowing, owing to interest rates. Understandably, these conditions would point to a greater risk being associated with stocks such as OMF, which serves clients in such stringent conditions.

However, several analysts such as John Hecht from Jefferies are of the view that these conditions could see non-prime lenders make big gains, as they cash in on a client expansion following stricter conditions from conventional banks. In fact, given this resilience, Hecht further claims that stocks within this class could be considered robust hedges against recessionary circumstances. Given the advantage alternative financing entities such as OneMain hold against conventional banks, I believe this claim to hold significant weight. However, a recession seems far from taking place, the underlying conditions of economic slowdown, and higher interest rates remain consistent.

I believe OMF to be ideally positioned to capture opportunity in the present circumstances, in addition to being a leading alternative finance company. Its focus on financial wellness would give it a significant edge over other players in the market, hence significantly lowering the risks it faces. Similarly, its fintech structure and integration of digital tools would allow it to greatly optimize its operations, and enhance its chances of being more profitable.

Earnings And Performance

In the recent quarterly results for F22Q1, OneMain saw a climb in its interest income against the prior year’s comparable quarter, with a jump from $1.06 billion to $1.09 billion. However, the company’s provision for finance receivable losses had jumped up from a negative $2 million figure up to a positive $238 million total. This was primarily due to the significant release of funds from the company’s allowance reserves in 2020 with the outbreak of the pandemic. In the present quarter, a substantial amount of these funds had been charged off, with delinquency rates stabilizing to pre-Covid levels.

Net income for the company had fallen from $413 million to $301 million, within a year. As a result, shareholders were faced with a drop in EPS from $3.06 to $2.36. However, this EPS figure had still been above expectations laid out by analysts, with Zacks consensus set at $2.15 per share. This was the fourth consecutive quarter for the company where the estimate had been surpassed.

Chart, bar chart Description automatically generated

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These results indicate that, although OMF is by no means immune to the macroeconomic swings impacting the wider sector, it is fighting the long fight, through its optimization-focused strategy, and is continuing to outperform the wider market.

Valuation

Despite all the strengths and growth potential of OMF that have been alluded to above, I believe the main strength the stock holds is how cheap it is trading in the market, given its earnings and growth-related metrics. The table below indicates a list of peer stocks from the credit markets:

Company

Market Cap

P/E

Forward P/E

PEG

P/Free Cash Flow

Dividend Yield

EPS growth this year

EPS growth past 5 years

Price

Visa Inc.

40.5B

37.75

23.87

2.08

33.05

0.75%

15.00%

13.60%

199.99

Mastercard Incorporated

315B

34.95

26.5

1.5

41.98

0.58%

37.40%

18.90%

335.9

FirstCash Holdings, Inc

3.4B

26.3

11.86

1.14

36.37

1.63%

18.80%

12.10%

73.77

American Express Company

113B

15.64

13.85

0.36

8.64

1.33%

166.10%

12.30%

156.1

OneMain Holdings, Inc.

5B

4.62

4.66

0.23

3.7

9.00%

82.50%

44.10%

42.24

Source: Finviz

As can be seen, OneMain holds a highly impressive profile with a PE, Forward PE, as well as P/FCF that is substantially below each of its peers. This indicates that in terms of its earnings, present, and future, as well as the free cash flow it nets in, OMF is trading at a price that is heavily discounted in comparison to its peers. Its significantly low PEG further reinforces this view, while suggesting the stock has significant growth yet to be realized in a steady bullish trajectory.

The dividend yield is another area where OMF sails ahead of its competitors by an immense margin. With dividends being paid to investors at a 9% yield, it is evident that the stock is the best money maker in the market by a long shot. In the past five years, OMF has undertaken the most significant growth in comparison to its peers, which I believe relates to its small size as an alternative finance company that is geared towards growth through optimization.

Given these metrics, it is evident that the market price for OMF suggests a heavy undervaluation. When coupled with the business strategy, and its resilience towards inflation as an alternative finance company, this significant potential makes sense.

Risks

It is difficult to ignore the fact that OneMain Holdings just like any non-prime credit provider could potentially be seen as a ticking time bomb by some in the market. The financial crash of 2008 was caused by lending to sub-prime borrowers without due diligence, which brought the entire banking system crashing down. These echoes of the past raise the question as to whether or not the business model itself can be sustained in the long term.

This risk of OMF clients defaulting is critical, given the fact that it is tied to a range of external conditions, each of which is beyond the realm of control of OneMain Holdings. These could be factors relating to the economy, such as unemployment, interest rates, and energy costs, or they could be events and catastrophes such as natural disasters, disease outbreaks, or even terrorism. The sheer web of possibilities that could go wrong for OMF raises some serious concerns.

Conclusion

OMF as a stock seems like a good choice to opt for, hence my buy position on the stock. Typically, an investment in credit companies that offer loans to non-prime borrowers would be seen as a high-risk initiative. However, OMF is different in many ways, given its focus on clients’ financial well-being and other forms of optimization through digital technologies to reduce credit risk. The stock is well-positioned to act as a strong hedge in the present inflationary environment, given its ability to rise above conventional banks.

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