Meaning, if one thought ADS could grow at 7%, have ROE's of 20% and has a 10% cost of capital then the P/B ought to be 4.3x. So for ADS to trade at 2x book (as suggested by a recent poster), the business has to deteriorate pretty significantly.
The way I’m looking at ADS, it’s valuation all comes down to the receivable growth.
If the card business earns $16 cash/share this year than the question remains if they can plow back this cash towards receivable growth? Historically, they reinvest, I think around 50% of earnings to support 15% receivable growth by keeping financial leverage at around 13. However, I think, the easy receivables days are gone. 2019 earning is likely to go back to buyback or debt reduction and not much to support the portfolio growth. Les say, 2019 EOY BV is $50 and net leverage multiple compress by 30%.
Starting 2020:
case 1) let’s say, receivable starts to pick up with ~7-10% earning, 25% ROE and 20% BV CAGR for the next 5 years. 50% earning goes towards portfolio growth by maintaining existing leverage ratio. what’s the value for this model? I think, at 12% earning yield today (or 2.7 times EOY BV), I expect to get 15 to 17% IRR just with the card business alone. Expected share price = $280 to $300 within the next 2 to 5 years (12 PE multiple or 2.5x BV).
Case 2) However, if the receivable slows or drops and the company decides to liquidate in 2021, what’s the liquidation value? I think $16Billion receivable should ask for a 30% premium i.e. ~100 cash/share (It’s just my guess estimate based on 25% yield, 7% default on 10Q receivable data matrix). With 2019 EOY BV around $50, I think the current share price is less than this future card business liquidation value. However, market is likely to push this to 2 times BV if receivable shows sign of weakness.