I'm betting the bad news is already baked into Bread Financial Holdings, Inc. (BFH) .
This Columbus, Ohio-based financial services company provides payment, lending, and savings services and products primarily through its 100 or so credit card partners, including Ulta Beauty (ULTA) and Victoria's Secret (VSCO) . The company also offers direct-to-consumer solutions through its branded Bread Cashback American Express (AXP) credit card and savings products.
The financial name might appear like it's crumbling, but I think it already is priced for a significant recession. Yes, delinquency rates are increasing but a lot of bad news appears more than priced into the current stock. If we have a mild recession or manage to skirt an economic contraction altogether, the shares could have significant upside. With solid option premiums, this name makes a good covered call candidate and it provides good returns even if the underlying equity just moves sideways in the coming quarters.
The company's funding mix at the end of last year was made up of wholesale deposits (39%), retail deposits (26%), secured borrowings (25%), and unsecured borrowings (10%). Over 90% of the retail deposits are FDIC insured. Co-branded and proprietary credit cards (as opposed to private label cards) account for approximately half of Bread's credit sales.
The stock has lost a quarter of its value since Silicon Valley Bank went into FDIC receivership early in March. The company posted better than expected first quarter results at the end of April. Bread's balance sheet is in solid shape, with the credit card concern holding cash of $3.6 billion against long-term debt of $1.9 billion. Debt has dropped 39% since the first quarter of 2020, when the new management team arrived. Capital ratios are in excellent shape with its Common Equity Tier 1 capital ratio at 20.2% and tangible common equity / tangible assets at 9.1%. Allowance for credit losses reserves were $2.22 billion, or 12.3%. In theory, these conservative metrics would give management the flexibility to increase the dividend, which at its current $0.21 per quarter, provides a yield of 2.75%.
Beneficial owner Turtle Creek Asset Management has used the depressed levels as an opportunity to cost average its position in Bread, purchasing 447,618 shares in early May between $23.50 and $27.00 a share. It's challenging to catch a falling knife in an environment where inflation is eating into consumer discretionary spending and a slowing economy (courtesy of Fed tightening) is deteriorating credit quality. With a strong balance sheet and over 90% of its direct-to-consumer deposits FDIC-insured, Bread is poised to weather the storm. Trading at around $30 a share with a tangible book value of $38.44 a share, the company is expected to earn over $21.00 a share over the next two years.
I expect those earnings per share forecasts to come down if the economic situation deteriorates further. However, a worse case scenario seems already priced in at current trading levels. Add in the extra risk mitigation of a simple option strategy, and BFH looks like a solid covered call candidate.
To establish an initial position in BFH using a covered call strategy, do the following. Select the September $30 call strikes as they have the best liquidity right now. Fashion a covered call order with a net debit in the $25.50 to $26.00 a share range (net stock price - option premium). This strategy provides downside protection of approximately 15% including dividend payouts over the four-month option duration. This strategy also has approximately 17% potential upside even if stock does little over the option duration.