Why Merrill Lynch Is Giving Up on Synchrony Financial, but Not on GE

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Synchrony Financial (NYSE: SYF) is edging closer to its total separation from General Electric Co. (NYSE: GE). While many analysts have prognosticated on what Synchrony may be like when it gets out from under GE’s shadow, 24/7 Wall St. has seen a key analyst downgrade from Bank of America Merrill Lynch on Wednesday.

The most basic part of the call is that analysts Kenneth Bruce and Charlie Pratt have downgraded the stock to Neutral from Buy. The firm’s price objective remains static at $33 in the call, which leaves an implied upside of only about 4%.

For a comparison to other analyst calls, Synchrony’s consensus analyst price target is $33.36. Also, the highest analyst price target is up at $38.00. As far as Merrill Lynch’s $31 price objective for GE, the firm is valuing GE above the consensus analyst target price of $28.43 — and GE’s street-high analyst target price is only $1.00 higher at $32.00.

The analysts believe that Synchrony Financial’s share price is approaching fair value. They also said that Synchrony’s management team has had good execution and that it now has a premium valuation against peers and a lack of near-term earnings catalysts.

On the bright side, Bruce and Pratt said:

Synchrony has delivered on its near-term growth targets and stronger than expected earnings in the two quarters since its IPO. The near-term operating metrics should remain positive, in our view, with platform revenues building due to healthy loan growth and spending volumes. Longer-term, we think the separation from General Electric will be a positive as it improves Synchrony’s float and is a precursor to a meaningful capital return. Our intermediate term earnings per share forecast is mostly in line with the Street, though lacks meaningful growth, as Synchrony positions for full separation.

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Merrill Lynch also adjusted its targets for 2015, 2016 and for 2017. Its projected price-to-earnings (P/E) ratio of 12.5 for 2016 sounds low versus the market, but investors need to consider that banking and consumer financial stocks just tend to be valued at multiples lower than the broad market. Those new EPS forecasts were as follows:

  • To $2.60 from $2.65 in 2015
  • To $2.65 from $2.60 in 2016
  • To $2.63 from $2.70 in 2017

These price adjustments reflect higher operating expenses now expected for 2015. One issue is front-end expenses being more loaded to mobile payments. Other key issues in the analyst call were as follows:

  • 2015 guidance that calls for loan growth of 6% to 8%
  • Net interest margin of 15.0% to 15.5%
  • An efficiency ratio below 34%
  • Roughly 5% average top-line growth over the next three years
  • Roughly 3.0% return on assets
  • A 12.5x P/E multiple to the firm’s 2016 EPS estimate