Ally Financial Q1 Earnings: A Strong Quarter, But There Are Pitfalls (ALLY)

After reporting better-than-expected Q1 2024 results, Ally Financial Inc. (NYSE:ALLY) is already up more than 20% since I last covered the stock in January of this year

About a year ago, I showed why comparisons between ALLY and other poorly governed financial institutions were not appropriate and indicated that the company could offer significant upside potential.

The total return since then has been even more spectacular, both on an absolute basis and when compared to the broader Financials sector and the equity market as a whole.

So far, the stock is up by more than 8% on the day, after the company reported its Q1 results. But before we go into the details of this quarter and what caused this initial reaction, we should take a closer look at the factors that influenced the stock price over the past 12-month period.

Ally Financial Share Price Drivers

First and foremost, we should not forget ALLY’s sensitivity to the term premium and interest rates more broadly. As we saw on the graph above, the majority of the return over the past year occurred since 1st of November.

The date 1st of November is important because that was when the U.S. Treasury Quarterly Refunding Announcement was published, and it came as a surprise to the market, thus driving the term premium down over the following months.

Yields on long-dated Treasuries fell and with that provided a major tailwind for risk assets.

Ally Financial’s stock has been a major beneficiary of this trend and as the expectations of rate cuts in 2024 are now cooling-off, ALLY returns are also likely to suffer through the rest of the year.

In addition, the company saw a major drop in its core return on tangible common equity in recent quarters, which, although largely expected, does not bode well for returns.

During the Q3 2023 earnings conference call, ALLY’s management indicated that they expect the net interest margin to reach its lowest point a couple of quarters after interest rates stabilize.

We expect NIM to trough a couple of quarters after rates stabilize, followed by gradual expansion each quarter, even without the benefit of rate cuts.

Source: Ally Financial Q3 2023 Earnings Transcript

Since then, rates have been going sideways and Ally’s NIM continued to decline on a quarterly basis.

In spite of all that, the stock continued to do well for one more reason – the extremely low expectations. Since mid-2022, sell-side analysts have become extremely bearish on the stock and have been rushing to downgrade their ratings in late 2022 and for the most part of 2023.

Naturally, this resulted in extremely pessimistic expectations about the future, which is why, ALLY jumped more than 10% on the day when the company reported its mostly in-line with expectations results in January.

With a supportive monetary environment and extremely negative expectations about the future, ALLY was well-positioned to outperform during the past year, and this is exactly what happened. Thus, the stock went from trading at levels below 0.75 of its book value to a price/book ratio of above 1.0 as of today.

It is essential that investors keep all that in mind when evaluating potential returns for the rest of 2024, even if the company continues to deliver on its quarterly results.

What Happened During Q1 2024?

As a leader in the automotive finance, Ally Financial continued to benefit from its strong pricing power within the field.

During the quarter we saw a meaningful increase in the total number of loan applications made which allowed Ally’s management to retain a low approval rate, without sacrificing growth.

More importantly, however, origination yield improved slightly and remains above 10% which would continue to have a strong positive impact on net interest margin through the rest of 2024.

Thus, the auto portfolio yield excluding the impact of hedges is expected to meaningfully improve from 8.65% during Q1 to roughly 9.4% by the last quarter of the year.

On the funding side, the total number of deposits increased $2.9 billion in the quarter and the interest increased to an average of 4.28% – a meaningful increased from the 3.23% a year ago.

Based on everything said above, net interest margin should improve through the rest of the year, provided that the tightening cycle is indeed behind us and deposit costs remain stable.

Increasing funding costs have been a persistent headwind since the tightening cycle began, but we’ve reached an inflection point as rates have stabilized.

Source: Ally Financial Q1 2024 Earnings Transcript

So far, Ally’s management remains prudent and has kept its net interest margin guidance for FY 2024 at 3.25% to 3.3% with the exit rate slightly above that.

This is the same as the outlook provided during Q4 2023 earnings call and could easily prove to be an easy target to beat. Higher earned premiums from Insurance were one of the key factors behind the better guidance on adjusted other revenue, which is expected to grow in within the 9% to 12% range for the year.

Investor Takeaway

The recent quarter has proven that Ally Financial is well-positioned to improve its NIM through the rest of 2024 and thus drive higher return on tangible equity. The stock, however, is now trading at a considerably higher multiple when compared to a year ago, and the main reason for that is monetary related tailwinds. Moreover, net interest margin is expected to improve marginally through the rest of the year. This means that unless ALLY could exceed its current guidance, then further upside for 2024 appears fairly limited.