Bread Financial Holdings, Inc. (BFH) Earnings Call Transcript & Summary

Thanks, everybody, for joining us. Before we get started, I have a quick disclosure to read, and then I'll get started. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So today, we're happy to welcome Ralph Andretta, CEO of Alliance Data Systems to our conference. Ralph has been CEO of ADS for almost 1.5 years now. And I think it's safe to say he's been through one of the more eventful periods ever for someone starting off the CEO of a company. Ralph, welcome, and I believe this is your first time coming to our conference.

Yes, Jeff, thank you. And I will say, I did have 3 good weeks before the pandemic hit. So it was fine. And I appreciate your time today. I appreciate everybody joining. I'm going to go through some prepared remarks, and you can find those slides on our investor website. And then I'm happy to take questions at the end. So I'm looking forward to that. So today, I want to cover our go-forward strategy, our strategic initiatives, talk a little a little bit about 2021, really update -- our update, including sales trends and what we're seeing and then expanding on our Bread opportunity. So I want to start on Slide 3 with our go-forward strategy. First, we offer a robust suite focused on customer choice which differentiates Alliance Data. So our product suite really differentiates us. We can offer our products through a white label or partner-branded option, which is unique to Bread in a buy now, pay later space. As well as that, we can go directly to consumers with our proprietary community card. The acquisition of Bread filled some product gaps for us. It opened up access to a younger, digitally native demographic. And through the use of our unified product offerings and a product graduation strategy, we provide an edge to our partners to better engage consumers by ensuring they have the right products at the right time, and we provide additional products as their needs evolve. We're able to support our consumers across the lifetime shopping experience which allows our merchants and partners to manage and optimize profitability through a deep integration. Our unified front-end experiences enable us to offer the widest payment suite. And any competitor in the space serving all generations and driving incremental sales for our brands, which is #1 priority for us. We believe our unified offering strategy is unique to Alliance Data and a key strategic advantage for us over competitors. Second, we provide a full spectrum of lending capabilities through the use of our advanced underwriting tools and our historic data to drive incremental sales for our partners. We can score and improve more applicants and enhance profits for both our partners and Alliance Data. The expansion of our product suite into buy now, pay later helps us further differentiate our grow and expand approach, which grants manageable credit lines and allows consumers to gradually grow their lines over time with proven payment behavior. Our risk appetite metrics are focused on credit risk and profitability rather than a targeted loss or delinquency rate. This balanced approach results in profitable, fair and responsible lending. Third, we will continue to enhance our digital capabilities. We are making it easier for consumers to apply and seamlessly transact across channels. Bread's versatile payment technology platform is scalable, nimble and allows for quick, simple integration for all our merchants. We will continue to invest thoughtfully to adapt to an ever-changing omnichannel world. And finally, we are committed to driving sustainable, repeatable, profitable growth. We will not chase deals that are not appropriate for our business, but rather we'll continue to prioritize relationships that expand the economic pie for us and our partners. We are confident in our ability to grow responsibly and provide a strong return on our shareholders' investments. If you move to Slide 4, data and analytics and technology innovation are other areas that would set us apart from our competition. We provide essentially real-time access to a comprehensive brand acquisition and sales data as well as underlying driver analysis, providing immediate insight into what is driving performance. Our data and analytics tools help our partners understand the changing behaviors of the consumer, analyze customer preference and develop internal planning and forecasting models. On the bottom of this page, you'll see risk -- proactive risk management, balance sheet management and expense management. We have taken deliberate actions in recent years to improve our underwriting platform. We have invested in our core platforms to enhance our predictive modeling and machine learning models, allowing us to provide lending approval rates within our risk tolerable metrics. Next, our recently announced spinoff of LoyaltyOne positions both companies to invest deeper in their unique growth strategies and strengthens Alliance Data's balance sheet. The spin-off will help to improve key metrics, including our TCE to TA ratio and our double leverage ratio with the target of having these more in line with our peers. Once we are comfortable with the level of enterprise capital metrics, we will ask the Board to consider additional capital returns to shareholders in the form of stock repurchases and increased dividends. Lastly, our growth outlook coupled with our disciplined expense management will set us up well to execute our long-term target of generating positive operating leverage in 2022 and beyond. We have the ability to flex our expenses up and down as needed, but we'll continue to make strategic investments in order to generate additional profit. Turning to Slide 5. Our focus is on execution. Sales are at an inflection point and will drive receivable growth going forward. We're confident of the growth drivers and opportunities, which will benefit us as payment rates begin to normalize and consumer confidence improves in the second half of 2021. While the economic recovery is robust in the States, outside the United States, it's been a bit slower, leading to softer-than-anticipated LoyaltyOne revenue in the first half of 2021. We are optimistic that the macroeconomic environment will continue to improve, leading to a rebound in the LoyaltyOne segment in the second half of the year, especially in Canadian air miles. We believe there's pent-up demand for travel. And as the year goes on, you'll see a robust travel, particularly in air miles. Given the strong credit metrics you saw in our monthly performance report this morning, we believe our next net loss credit rate will be in the low 5% for the second quarter. We'll provide some guidance in the second half of the year during our earnings release later on during our earnings call and -- after the second quarter ends. We continue to make investments in key areas. Expenses will increase in the second half of 2021 as we continue to optimize the Bread platform, invest in digitalization and analytics, increase marketing and move forward with the transition of our core processing to Fiserv. The Bread platform investments will position us well for anticipated platform growth in 2022. Again, although you'll see expenses ramp up, we can modify those expense -- ramp those up and down as appropriate. I want to spend a moment on Slide 6 and to avoid any confusion we are comparing 2021 sales growth to 2019. We feel that's a fair comparison as 2020 with all the COVID-related issues and shutdowns and open ups and shutdowns really isn't a fair comparison. So what you see on this page is 2021 compared to 2019. You can see the continued gradual recovery in credit sales for our card services businesses, which aligns with the improvement in the consumer confidence and mobility metrics. The mobility tracker is based on time spent away from the home estimated by using cell phone location dates. As a result of the increased activity in store, brand sales continue to rebound, while online sales remained strong. Millennial shoppers have surpassed their pre-pandemic spending levels with double-digit growth year-to-date compared to 2019 in our traditional card private label credit card business and co-brand channels. We are encouraged by the progress we are seeing in the economy and remain optimistic that these proactive trends will continue. Lastly, I'd like to spend a couple of minutes on the Bread revenue models. Bread continues to be a key growth driver for us and is instrumental part of our strategy going forward. We have significant opportunities to drive value across Bread's 3 business models. First, a direct acquisition model. This model provides us with the highest revenue opportunity since the receivables are on our books, and we are not sharing any fees with the third party. We have a well-established relationship with over 130 of our partners that are interested in the adding buy now, pay later and installment loan capabilities as product offering. And the Bread sales team continues to add brand partners to align our timing to medium-sized retail and small-sized retailers. We are in ongoing discussions with our brand partners to allow on timing and staging of the integration and technology road maps over the next year. Our software development kit, an enhanced digital suite provides our partners with a simple quick integration and easy access to seamlessly offer all full suite of products. So most importantly, to get our partners to adapt that software delivery kit and our enhanced digital suite makes it easy for them when they want to move to a buy now, pay later and installment loan product capabilities. It's a seamless integration. The distribution model provides us with a slightly lower revenue opportunity than the direct acquisition model since we pay a merchant acquirer a fee. However, the returns are still very attractive. Importantly, this channel provides us with growth opportunities that we wouldn't otherwise have if we're only pursuing the direct acquisition model. We expect some early launches with Fiserv in the third and fourth quarter of this year before scaling in 2022. Lastly, the technology platform gives us the third avenue for growth. While revenues are certainly lower on an absolute level than return -- but the returns are attractive. In this model, we don't hold the receivables on our books, but it does provide us with no credit risk revenue stream. We get fees from the transactions. Bread's capabilities enhance our overall ability to compete in the payment space. Bread's white-label, deeply integrated, scalable solution coupled with Alliance Data's ability to provide full spectrum of underwriting, strong customer insights, robust compliance and low funding costs are key differentiators from other fintech competitors. The combination of our traditional PLCC and co-brand offerings, the enhanced digital suite, our community card and Bread capabilities position us well to win new business as well as retain existing business and brand relationships, which gives us confidence on our long-term growth ambitions. We are excited to drive the business forward while maintaining our focus on providing long-term value to shareholders through sustainable, profitable and repeatable growth. Jeff, thanks for the time, and I'm happy to answer a few questions.

Thanks, Ralph. That was great. Thanks for the presentation. Before we dive in, I want to just give a quick reminder to everyone on the webcast that if you have any questions, you can submit it in the submission box below the video on the website. Ralph, so just maybe digging into Slides 3 and 4, a little bit more on your strategic vision for the company. When we think about everything you've been able to put in place over the past 16 months, there's been a lot of things. You've shored up the balance sheet. You've been hiring people. You bought Bread, you've launched these new partnerships. As we start to look beyond the pandemic here, do you feel like ADS has the entire toolkit in place that needs to succeed? Is there anything else you think you need to add or might be missing?

Well, I think you never have the entire tool kit. You always want to look over the horizon and see what's next and make sure you're current. But as it stands today, our focus right now is execution. We've launched a lot of things. We've -- as you said, we bought Bread, we're outsourcing our core processing to Fiserv. We've outsourced ancillary activities. We've beefed up data and analytics. So we're excited about things that we've launched and where we are. And our focus is maniacally focused on execution, we have to spend in care for this year as well. So there's a lot going on. So in the near term, do I anticipate an another acquisition? Probably not. I anticipate really getting the most value out of the things that we've launched over the last 16 months.

And then if I just kind of think about what's been happening so far, the pandemic isn't quite over yet. It seems like on Slide 6, you're calling out quite a nice recovery in your credit sales. I know you're looking at it versus '19, but I think that implies something like a pretty strong 50% increase year-over-year, if I have that right. When do you think we'll surpass 2019 levels? And how are you thinking about the trajectory beyond that? Are there any pockets of strength you'd call out?

Yes. You know as we -- I think you'll see that pick up in the third and fourth quarter. I think we're seeing people's behaviors change from hoarding to spending. And I think that's going to be important. So I think we're going to exit the second quarter pretty good, probably not at 2019 levels. But I think in the third and fourth quarter, you may see us at or above those levels as we move forward. And I think you'll see that continued trajectory. I think consumer confidence, and I'll speak for the U.S. is coming back. It's pretty robust. And I think you'll see that translate into sales for us. And then ultimately, sales will translate into receivables.

Is there any -- I know that you were calling out the kind of return to in-stores driving a lot of this recovery? Are there any trends you're seeing? Are there any types of stores that are driving the market? Are there any laggards still? And I know you called out millennials being a source of strength. Are there just any kind of little things like that you could point out?

Yes. We're seeing it in a lot of the verticals. So we're certainly seeing it in retail and soft goods. We're seeing -- still seeing it in home improvement. We're still seeing people kind of sprucing up their homes. So we're still seeing it there as well. We're starting to see it in pets, in pet care and all those things. So not one vertical standing out positively and negatively. We're seeing a nice trend across all our verticals. And while stores are coming back, and we see good acquisition, our digital sales are at a solid 40% and the pie is getting bigger. But as you think about the growth of Bread and the growth -- our Fiserv partnership relationship, you'll see that digital sales will continue to grow. I think the entire pie is going to grow, but I think you'll see digital sales grow over time as well.

So speaking of loan growth, I mean, this morning, you also put out another pretty solid set of data, both on credit and loan growth. So maybe focusing on the loan growth piece, you're also highlighting in Slide 5, this kind of inflection you're getting. And I think you were one of the few names to actually see a downtick in your payment rate this month. So I guess what I'm wondering is, is there any reason we shouldn't see upside to your loan growth in the second half of this year. I think you're calling for more of a flattish outcome this year?

Yes. It's -- we did see a bit of a downtick, but still over last year. So although payment rates have modified a little bit, they're still greater than they were last year. And I anticipate late in the second half of the year, you'll start seeing some loan growth. We've never been faced with this type of economy. There's trains of dollars of recovery in the economy between stimulus, unemployment benefits, suspension of student loans. That's all rolling off. Now people are getting out spending. And you may see that payment rate moderate or flatten as we move forward. If that does happen in the second half of the year, late second half of the year, you'll start to see loan growth.

And then just as we think about the longer term, I mean, at your recent Investor Day, you were putting out some pretty robust growth targets. I think you're calling for this kind of high single-digit growth rate with maybe some upside to low double digit in '22 and '23. One of the biggest questions I get is, is this really achievable? I think it's been a number of years since ADS has been able to consistently deliver on this kind of growth. What gives you such confidence to get there?

I think a couple of things. I think If you think about our business -- I'll call it our traditional core business, right, the PLCC and the co-brand, we're now able to go deeper with those businesses because we have new products. So just think about that business alone that business to me, with our new products and data and analytics and really focusing on growth will give us single-digit growth, mid- to high single-digit growth. I think the acquisition of Bread and the ramping up of Fiserv and going direct-to-consumer aside from our core businesses, that's where the incremental growth will come from in the high single digits, low double-digit growth. So it's a combination. It's not a home run. There's a lot of doubles and singles and maybe a triple in there, but it's a combination of deeper penetration, and new frontiers for us. And that's what I -- that's why I have confidence in the high single-digit, low double-digit growth over the course of the next few years.

In all those kind of upside things you're talking about are, what take you to the $20 billion number you're talking about for '23, right?

No, it's exactly right. It's all inclusive of that $20 billion of average receivables in 2023 is a combination of all of the above.

And how does Bread specifically factor into those growth plans?

They're a big contributor to those growth plans because if you think about it, they impact our current core business by offering our current core business buy now, pay later. They impact our direct-to-consumer when we sign merchants and through the direct model we talked about. They impact us in a distribution model from a receivables perspective because of the ramp-up with Fiserv and the scale we get there. And from a revenue perspective, they impact us in the technology platform for the recurring transaction fees. And that to me is like almost a network fee. It's a low-risk revenue stream. So they play -- we're not breaking them out specifically, but they are within our Card Services revenue group, and they play a significant role.

And when you talk about the growth there, I think you've kind of talked about this more than doubling this year. Do you have any high-level sense of where that could go beyond this year?

Yes. I think they'll more than double this year. And we've talked about approaching $10 billion. I think that's 2023, that's where we'll see it going. And it's all in how fast we can ramp up and how fast we can scale. And to take a step back, we've had Bread for less than just about 6 months. And the integration is well on target, and we're able to announce 2 or 3 big things. So we're excited about that. And it's a matter of how fast we can scale and how fast we can scale with some partners. But that's great. I think in 2023, you'll see us nearing that number.

Got you. And just that $10 billion GMV figure that you mentioned by '23, I think one of the areas I got -- that's one of the areas I get a lot of questions on, is how can you get to $10 billion when I think some of the other incumbents out in buy now, pay later are just starting to kind of hit those run rate numbers. What do you think about your model lets you get there similar pace as them?

Yes, a couple of things. So we're a full-service financial institution, right? So we've got 130 partners that we can tap and go deeper in penetration, right? So as I said, the most important thing is that software delivery kit and the enhanced data suite getting that install with our partners so they can switch on or buy now, pay later installment loan. And if you think about what we do as opposed to the competitors, we have relationships with these partners. We're not transactional. We have a relationship. It's a repeat relationship. We have all the data and information. We could drive a transaction and create a transaction instead of just get a transaction. I think that makes us different. And if you think about pricing, we can price on a relationship basis. We're not going to deep discount, but we have a relationship, and we could do things on a relationship basis. That gives me a lot of confidence that we can move swifter than others. And right now, buy now, pay later is it's gaining traction. People are embracing it more so than we've been talking about it for a while. People are starting to embrace it now. And so I think we'll -- we're well on our way to gaining traction. The relationship with Fiserv helps us. We can bring data and analytics for that relationship, and there's scale there, and that's important to us as well. So listen, I'm bullish on buy now, pay later installment loan. I'm bullish because we bought that in the pandemic. We acquired Bread in the pandemic to close product gaps. And we were very much focused from day 1 when I got here that we were going to close this product gap. And we did it, I believe, in the quickest way we could, which is buying -- we didn't build, we didn't partner, we bought, and now we're driving that across our entire enterprise.

No, that was certainly -- it was certainly a very timely acquisition. And I guess one of the questions that we also get on that is all right, what if you have a retail that already offers buy now, pay later? What's the strategy to go after that? Is it more of a side by side? Do you want to get exclusivity? Are you going to undercut them? Or are you going to try to do this relationship pricing? What's your goal to win there, strategy to win there?

Yes. Listen, exclusivity is important but not essential, the way I think about -- I'd love to have exclusivity. But these buy now, pay later deals with the fintechs, they're short term. They are a year, 24 months at tops. They're not exclusive. Again, we can offer a suite of products to the partner or to the merchant. We're not a one-trick pony anymore. We have a suite of products that can address a number of lending needs that customers might have. We have -- I talked about it earlier, we have a fluid data and information on our partners' customers because we are their partners. It's almost a closed loop. If you think about a closed loop of information. We know their buying habits. We know when we can provide a marketing opportunity for buy now, pay later or installment loan or something else. I think that's a positive, which our competitors don't have. Again, it comes down to the relationship that we have with them. Most competitors, they want you to download their app and that's what they want you to use, agnostic of the merchant. We're focused on driving value for the merchant as well as us. That's the important part to me. We're going to grow the pie for both of us. We're not looking to dismediate the merchant. We're looking to enhance the merchant's opportunity. And I think that will catch on. I think they will see that. I think we'll show them the value added that we have, and you'll see things certainly help to move in our direction.

And as you add more value to these retailers, perhaps you're able to maintain that kind of market rate that's out there right now in buy now, pay later, but I think there was a very big competitor out there that recently said the other day at our conference that he expects to see significant pressure on discount rates there. I was just wondering what do you think of that comment. And how do you think ADS will evolve if that happens down the line?

Yes. So we've -- I've not seen any pressure yet to be very -- it may be out there, but I haven't seen any pressure yet. But I think we'll be able to absorb that because, again, we're not pricing a transaction. We're pricing a relationship. And I think we'll be able to adjust accordingly, still be profitable and still be attractive to our partner because we have other levers that we work with them on. So you're looking at a rate card almost as opposed to one transaction fee that they have to get. So that's the way I view it. Relationship pricing is always -- there's always a benefit to that as you work with partners.

And is that more just you can kind of -- when you say the relationship pricing, you're talking about how you can pivot to different products? Or are you just charging for the entire sale that goes to them regardless of what platform or like could you talk a little bit more?

Sure. I mean, we have different revenue streams with the partners that we can adjust accordingly, right? So there could be -- we could take a -- there may be a revenue stream where private label, we price it at a rate that gives us the opportunity to drive -- to potentially reduce the rate on a buy now, pay later transaction because as a whole, 1 and 1 is going to equal 3 because we have multiple relationships from a revenue perspective and a product perspective. So we could price accordingly for profitability, not just price a transaction for profitability.

And you just launched Apartment 2B, I think, and you probably have a couple more in the way. Just can you give us a quick update on how the rollout is going? And maybe should we -- how many should we expect the next quarter or maybe we -- how to think about the cadence to come?

Yes. I think you'll see a number of launches in the second quarter. you'll see a few more in the third quarter. And I think you'll see that robust move going into 2022. I think that's what you'll see. As I said, if we could -- we're working with them now to really focus on that software delivery kit and the enhanced digital suite. That makes us the switch to buy now, pay later installment loan seamless and quick. So as long as we're working with our partners to install and move forward there, the launches will be -- that's kind of the heavy rock right now, and the launches after that will be seamless and continuous. That's the way we view it.

And do you have any expectation that maybe one of your larger ones will be coming through anytime soon? Or is that...

Yes. We're in negotiations with the larger ones. But as you would imagine, like any large company to get into their tech stack and their tech prioritization, we're working through that now. We have a big launch coming up with Fiserv. And so we're focused on that, which is distinctly different from this year but all our partners have different types of launches out there. And so we're working to prioritize and get into their tech stack, but we're working with our larger partners for execution on that.

I actually had a question come through. I know we already discussed the merchant fees, but do you have a personal view of where you see the buy now, pay later merchant fees going?

I think the market is going to set the price like anything else. But what I do know is that our cost to serve and our end-to-end servicing will enable us to be very, very competitive wherever that price is set. If you think about us as opposed to the traditional -- the fintechs that are out there, we underwrite a bit better because we've been in the business for a very long time. We have good credit and collections. We have good servicing. We've established that over a long period of time, right? So we're not building that, we're enhancing that and taking this buy now, pay later installment loan functionality and using all the tools we've traditionally used over the years to drive better profitability. That's why wherever the price settles, I think we'll be very competitive.

Maybe let's switch gears a little bit and kind of focus on some other important news happening to the company. I think we spent a lot of time on Bread already. You recently announced the spin-off. You just mentioned earlier in our conversation that you're trying to achieve peer levels of tangible common equity. I think you kind of highlighted that in your Investor Day as being a high single-digit, low double-digit range. I think when I look at your peers, though, they tend to kind of shake out normalized in the high single-digit. So why would you get to the low double digit? Is that because you want to hold more capital for potential loan growth? Or help us understand that?

Yes. I mean listen, I gave a range, but the low single digits would be very -- a pure level would be very attractive for me, that's where I'd like to be. High -- if you get to the high single digits, that's great. It means you have excess capital, you can acquire a bit more. But the low single digits is really my comfort zone when you -- then you talk about return to shareholders.

And one investor question that actually came in was what will the EBITDA and debt split look like between Card Services, LoyaltyOne, post-spin? When can we expect the spin to occur? So I mean, to the extent you can answer.

Yes. You can expect a spin to occur in the fourth quarter. That's what we're working towards. We'll have more information on the split stand, but it will be fourth quarter that we'll -- the spin should occur. And we're on schedule.

Okay. And your -- you mentioned earlier in the conversation, one follow-up that LoyaltyOne perhaps a little bit lagging in the first half of this year. Does that impact any of the financials or plans that we should expect with the spin? I know that you've talked about the 2Q financials as being kind of a driver of what you'll do with the debt and so forth. Is there maybe a delay there? Or is that all on track still?

No, it's on track. So I think it's all about timing. So let me break LoyaltyOne into 2 businesses that we have. One is Brand Loyalty, which is our business in the Netherlands. They're on track there. We've seen good growth in the second quarter. AIR MILES, our business in Canada, is a bit behind. And they were not behind because of any structural issues. They're behind simply because of the pandemic. So similar to when the U.S. opened up, we saw a spike in sales. We're anticipating seeing a spike in travel in the third and fourth quarter. So I would say it's not a miss, it's a delay.

And we haven't really spent a lot of time on credit yet. That's probably a first for ADS, I think. But given the robustness of what we're seeing come through, I guess I was just curious on a couple of things. Are you still comfortable with this kind of sub-6% through the cycle loss rate? Is the strength you're seeing changing that at all? Or maybe what kind of trajectory you're looking for through 2022? And then the other thing would be, you recently highlighted 40% of your book is now below 660, I think. Do you expect that to change? Or have you changed your underwriting versus prepandemic in other ways?

Yes. So I think we've -- one of the things that I found here that was very a pleasant surprise, although when I -- we have a terrific team around credit and collections, very sophisticated. I'm really pleased. I've worked at American Express, and I worked at Citi. So I've come from companies that really knew how to manage credit. And I was really pleasantly surprised to see how we manage credit here using Vantage 4.0. But I think 6% through the cycle is adequate. We'll be in the low 5s in the second quarter. We'll give more guidance in our earnings release later on as we close the second quarter. But I see us at below 6% through the cycle. I think that's a good number. Our prepandemic, we -- our recession readiness plan went into place. We're very prudent about how we would manage our risk. We're not changing any of our risk policies, although we are opening up to pick it a little bit in Bread because that's where it was a little tighter. So you'll see us probably underwrite a bit more in Bread, which is to our advantage. But I'm very pleased at the end-to-end process we have here. So I'm comfortable with the 6%. Payment rates are -- they -- hopefully, they'll moderate as we move forward, but I feel good about that through the cycle.

Okay. Great. I think we're just about out of time. So I want to thank you, Ralph, for joining us today. It was a pleasure. Hopefully, we'll get to do this in-person next year. And thanks, everyone, for joining.

I'm looking forward to doing it in-person. I really am. So it will be a pleasant change.

Yes. Thank you, everyone.

But thank you. Thanks for your time, and thank you, everyone, for joining. I appreciate it.

Thank you.