OnDeck Capital Inc. - earnings outlook warrants higher equity value

/

Strong delivery in June driven by loan repricing

The June quarter results were strong driven by interest income, which beat analyst estimates. The management focus is increasingly on margins as opposed to top-line growth. The pace of volume growth in the quarter is indeed slow but the EIY has more than offset the shortfall in originations. FICO scores are trending up; the probability is now looking higher that cost of risk will surprise for better increasing the likelihood for a material earnings surprise in 2019/20. It is conceivable OnDeck's GAAP earnings in 2020 will approach $30M mark, which could imply at least $50M in earnings with stock-based compensation added back.

Upside risk to earnings and equity value

The consensus is slowly catching up. The sources of positive surprise include

  1. further gains in margins: the EIY should rise towards 36.5% in 2H18 versus 36.1% in the June quarter and higher in 2019
  2. risk cost trending down more than the analysts factor in
  3. recovery in ODaaS business

The stock could be trading on 12-13x on 2020 adjusted earnings or 1.8-1.9x on book equity. Given massive pick-up in earnings and 15-16% ROE outlook, we find these multiples compelling They should rise to reflect the outlook. 

About OnDeck Capital

On Deck Capital Inc. is one of the leading on line financial intermediaries with specific focus on lending small enterprises. The company provides term loans (since 2007) and lines of credit (since 2013) to small businesses. OnDeck has over $7 billion in originations serving over 70,000 clients as at 2017 year-end. The model is scalable as the penetration in on-line small business lending remains low. The management believes there is $80-120 billion in unmet demand for small business lines of credit. Based on that size, On Deck serves less than 9% of the market. They currently operate in the U.S., Canada and Australia. OnDeck has developed proprietary analytics and credit scoring models, key to the sustainability of the business model. Approximately two-thirds of OnDeck liabilities are "notes and certificates," which are unsecured structured notes tied directly to specific underlying customer loans.