Decisive Overhaul To Boost Efficiency And Unlock Shareholder Value In Consumer Finance Sector

Key Takeaways

• Navient's strategic focus on cost reduction through outsourcing and divestment aims to improve net margins by lowering operational expenses.
  
• Expansion into high-quality private student loans and significant restructuring efforts emphasize growth and operational efficiency, potentially enhancing profitability.
  
• Restructuring and workforce reduction risks impacting operational efficiency, coupled with regulatory challenges and outsourcing, could significantly affect profitability and customer satisfaction.

Catalysts

Provides technology-enabled education finance and business processing solutions for education, health care, and government clients in the United States.

• Navient's focus on expense reduction, specifically through its servicing outsourcing agreement with MOHELA and the expected divestment of its Business Processing Solutions division, indicates a strategic move towards achieving significant annual savings in the hundreds of millions of dollars. This reduction in operational costs is likely to improve net margins by lowering overhead and operational expenses.
  
• The completion of the outsourcing initiative with MOHELA, including the transfer of nearly 900 employees, transitions Navient to a variable cost servicing model. This shift aims to make their cost structure more flexible and scalable in accordance with loan servicing demands, likely enhancing the company's operational efficiency and contributing to improved net margins over time.
  
• Active discussions regarding the divestment of the Business Processing Solutions division suggest potential for unlocking additional shareholder value through the strategic reallocation or return of capital. The proceeds from this sale could be used for investments that ensure higher returns, debt reduction, or direct shareholder returns, which in turn might increase earnings per share (EPS).
  
• The emphasis on leveraging the Earnest business to generate high-quality private student loans and explore further growth opportunities signifies Navient's focus on expanding its profitable segments. This strategic push towards growth in lending could lead to increased revenue and contribute positively to the company's bottom line.
  
• Navient's planned significant reduction in shared service infrastructure and corporate expense footprint, including an employee count reduction to 80%-90% lower than current levels, outlines a robust cost-containment strategy. This extensive restructuring effort is expected to have a profound effect on reducing operational costs further, enhancing overall profitability and potentially making Navient's stock undervalued at present considering these future growth catalysts and operational efficiencies.

Assumptions

• Analysts are assuming Navient's revenue will decrease by -30.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 15.5% today to 37.9% in 3 years time.
• Analysts expect earnings to reach $131.0 million (and earnings per share of $1.88) by about September 2027, down from $160.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.7x on those 2027 earnings, up from 10.5x today. This future PE is greater than the current PE for the US Consumer Finance industry at 9.8x.
• Analysts expect the number of shares outstanding to decline by 10.03% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 10.74%, as per the Simply Wall St company report.

Risks

• The strategic restructuring, while aiming for significant expense reductions, exposes the company to the risk of execution failure that might adversely affect cost efficiency and operational flexibility, potentially impacting net margins.
  
• Outsourcing of servicing to MOHELA and the potential divestment of the Business Processing Solutions division introduces operational risks, including potential disruptions in service quality and efficiency, which could negatively affect revenue and customer satisfaction metrics.
  
• The ongoing regulatory expenses, especially those related to the CFPB lawsuit, introduce financial uncertainty. If these regulatory challenges grow, they could impact net earnings through increased legal and compliance costs.
  
• The mention of elevated levels of loan prepayment activity accelerates the timing of cash flow but might reduce future net interest income, directly impacting the net interest margins and overall profitability of their FFELP and private loan portfolios.
  
• The restructuring efforts leading to an employee base reduction of 80% to 90% could lead to short-term operational inefficiencies. This drastic reduction in workforce might impact service delivery and operational efficiency, leading to potential revenue losses and negatively impacting earnings until the new structure stabilizes.

Valuation

• The analysts have a consensus price target of $14.25 for Navient based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $16.0, and the most bearish reporting a price target of just $10.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $345.8 million, earnings will come to $131.0 million, and it would be trading on a PE ratio of 11.7x, assuming you use a discount rate of 10.7%.
• Given the current share price of $15.42, the analyst's price target of $14.25 is 8.2% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.