Loyalty Programs Make This Tech Giant A Worthy Buy

Nick Lanyi's picture

Friday, July 1, 2016 - 12:30pm

by Nick Lanyi

The credit card was popularized in the United States in the 1950s, when Diners Club, Care Blanche and American Express created national -- and then global -- networks that allowed card holders to charge to a variety of merchants.

Loyalty reward programs date back to at least the 1790s in the United States; they've remained popular throughout the centuries -- from trading stamps through box tops to the present-day airline-style points programs. In the mobile digital age, when consumers have instant access to dozens of shopping options, loyalty is especially important. Consumer-facing companies now aim not only to attract purchases but to build networks of loyal customers. Online marketing programs are tailor-made for such efforts, as they allow companies to inexpensively reach customers with targeted appeals.

Today, many large retailers have their own credit cards; almost all consumer-facing companies have loyalty programs that reward customers who return to buy their products and services again and again; and almost all such companies also have multi-channel marketing efforts that include sophisticated online programs. One of the leading companies that help manage all of the above is Alliance Data Systems (NYSE: ADS).

Alliance describes itself as "the engine" behind marketing and loyalty programs at more than 1,000 companies around the world. It's also one of the more interesting "Big Data" plays on the market today. 

The company serves clients in the retail, travel, pharmaceutical, auto, financial services and other industries, and its business breaks down into three units:

The card services business, which accounts for about half of revenue, manages 140 "branded credit" programs, which are private label or co-branded credit cards -- often linked to a retailer, such as Macy's or Victoria's Secret. The Epsilon unit is one of the country's top marketing agencies, creating campaigns to reach consumers through digital devices; its clients include nine of the top 10 banks, eight of the top 10 retailers, the largest automakers and the top 10 pharma companies. And the LoyaltyOne unit helps companies create and manage loyalty and rewards programs in the United States, Canada, Latin America and Europe.

These three businesses have one important quality in common: data. All three generate an enormous amount of information about the buying habits of millions of customers, helping Alliance Data refine its offerings in all three units. And while the card services business is certainly cyclical -- its profits go up in stronger economic times and are hurt when consumer spending weakens -- the Epsilon and LoyaltyOne units generate steady growth regardless of the economy's strength. That's because companies are especially interested in generating additional sales when consumers aren't spending.

The company's revenue has grown from $2 billion in 2009 to an estimated $7.1 billion this year; over the past five years, revenue has increased at an impressive compound annualized rate of 15%. Earnings per share have increased at an 18% annualized rate during the past half-decade. While those growth rates are slowing as the company becomes larger and more established in its markets, analysts look for sales and earnings to increase at double-digit rates over the next few years.

Alliance's profit margins are rising, and the company generates strong free cash flow of about $1 billion a year, which it has reinvested in new technologies and used to buy back its own shares.

Alliance is somewhat difficult to value, because it's a hybrid of a credit, marketing and data provider. But today, there's little question that the stock is undervalued. It trades at only 12.3 times analysts' consensus estimate for 2016 earnings per share, about equal to its expected earnings growth rate over the next five years. That's a bargain. And at recent levels its shares are about 37% below their 52-week high.

Risks To Consider: Alliance Data's Card Services business is vulnerable to an economic slowdown. And all of the company's business lines are highly competitive, which could result in disappointing earnings or profit margins in any given quarter.
    
Action To Take: Buy Alliance Data (NYSE: ADS) below $210.

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Nick Lanyi does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.