Pair Trade: American Express Vs. Synchrony Financial

Previewing the third-quarter results of consumer/commercial financial services sector, Bank of America Merrill Lynch highlighted a pair trade. The firm downgraded shares of Synchrony Financial SYF, even as it said it remained bullish on American Express Company AXP.

A pair trade is a trading strategy in which opposing positions are taken in a pair of highly correlated instrument. This market-neutral strategy serves to mitigate directional risk.

As such, BofA Merrill Lynch downgraded shares of Synchrony Financial from Buy to Neutral and reduced its price target from $35 to $33. Meanwhile, the firm maintains its Buy rating on the shares American Express, with a $102 price target.

Visibility Into Synchrony's Earnings Poor

Analyst Kenneth Bruce attributed the downgrade of Synchrony Financial to the lack of 2018 earnings per share visibility, which creates an overhang on the stock at current levels. The analyst said it views Synchrony Financial as a somewhat controversial stock.

That said, the analyst noted that investors are cautious, given a series of credit-related earnings per share disappointments over the past year. The analyst believes the stock can break out of its near-term $31-$32 price resistance, if visibility into credit and the earnings per share trajectory improves.

BofA Merrill Lynch said a further weakening in Synchrony Financial's relative credit performance will pose downside risk. The firm clarified that the revised price target of $33 reflected a ten times PE multiple to its 2018 earnings per share forecast of $3.32, down from the 10.5 times multiple previously.

Bullish On American Express On Business Momentum

However, the firm said it is bullish on American Express due to the positive momentum in its core business and improving optics to its primary growth metrics for the third quarter. Following meetings with the company's chief financial officer, the firm said it came away increasingly confident that its near-term business momentum would serve to bolster confidence in its ability to deliver sustainable revenue and EPS growth prospectively.

The firm also said it does not anticipate any news on the Starwood co-brand deal until later this year. Although the firm expects this to serve as a modest overhang for American Express, it is of the view strong operating results could drive the stock higher.

Specifically, the firm expects American Express to report third-quarter earnings per share of $1.48, in line with the consensus estimate. The firm said the recovery in the company's core business will become all the more visible, as the post- Costco Wholesale Corporation COST metrics fall out of the year-over-year comparisons.

This, according to the firm, will provide cleaner evidence that American Express is achieving top and bottom line growth. While the firm does not expect the company to revise its guidance, it believes the management will begin talking up its recent outperformance.