In the first quarter of 2022, Berkshire Hathaway (BRK.A)(BRK.B) purchased close to nine million shares of Ally Financial (ALLY), a digital bank that specializes in auto lending. He now owns around 30 million shares, valued at over $1 billion.
The market has punished Ally this year but is it missing something. Does Buffett see something others don’t?
The Rise Of Ally Financial
Ally Financial was founded in 1919, and by 1924 the company had financed its four millionth vehicle.
In the 1940s, Ally began financing more than cars, making everything from airplanes to household appliances more accessible.
From there, the company evolved and today Ally Financial offers financial services spanning car finance, online banking, vehicle insurance, mortgage loans, and more.
In April 2014, Ally Financial went public, offering its stock for $25 per share. Growth was relatively slow, and the road was bumpy until 2020. The pandemic led to a strong auto market, and Ally Financial benefited — and so did the company’s shareholders. In March 2020, shares sold for around $12 before soaring to $55.29 in June 2021.
The company’s strong results stemmed from supply chain issues within the auto industry, especially semiconductor chip shortages. Inventory was low and car prices soared, especially used cars.
Flow of Loan Applications Is High
Ally’s latest quarter also included some strong results, including $13.3 billion in consumer auto originations, representing the highest quarterly originations since 2006.
Although most figures were lower than in the second quarter of 2021, Ally still delivered strong operational results, continuing into Q3 2022. Application flow remains high, Ally’s financials are solid, and the company’s annual dividend is 3.6%, so why is its valuation so low?
The Downside Of Higher Car Prices
Based on Ally’s great results and excellent near-term demand, it’s tempting to ignore the looming challenges. However, this is a case of what comes up must come down. When conditions normalize to pre-COVID levels, Ally risks exposure to credit and funding thresholds. This concern is particularly valid considering how loan balances ballooned alongside hikes in car prices.
In Q2 2022, Ally saw a rise in its 30-plus-day delinquency rate, which jumped from 2.02% to 2.52%. Although this rate is below pre-pandemic levels, investors are still nervous. The question is whether Ally Financial can sustain its recent strong returns.
The Upside Is Big
There is no doubt that Buffett eyes investments through a long-term lens. He also knows the car business quite well, so this investment matches another philosophy Buffett adheres to — don’t invest in something you don’t understand. Ally is also the 22nd largest bank in the U.S., and it’s no secret that Buffett is a fan of bank stocks.
It’s uncertain what Buffett’s exact thought process is. However, it appears that the management team is prepared for a normalization in car prices.
The company is modeling a 30% reduction in used car prices from the end of 2021 to 2023. Also, Ally offers more than just auto lending. From mortgages and credit cards to point-of-sale lending and wealth management, Ally’s business can lead to a higher-quality deposit base.
Buffett and Berkshire are notorious value investors. In this case, they believe that Ally’s stock is trading for less than its fair value. Perhaps it is this low valuation that smoothes over the current risk-reward scenario. After all, Berkshire’s stake in Ally is only around 0.3% of its massive $300 billion stock portfolio.
Our calculations reveal Ally is significantly undervalued to the tune of 31.4%. We place fair value at $42.97 per share, which is slightly below the Street consensus of $45.95. Either way, the appeal of Ally is evident if his estimates are in this range.
Is Now the Time To Buy ALLY?
So although you can expect volatility over the next few quarters, Ally Financial should benefit from rising interest rates and the continued demand for vehicles and auto loans. The stock is down over 31% year to date, so if you like what you see and are on team Buffett, now might be the time to buy a few shares.