Industry: Information Technology–Data Processing & Outsourced Services; PEG = 0.96; P/E = 13.8

Alliance Data Systems (ADS: Current Price 228.55) provides data-driven and loyalty transaction-based marketing services to businesses in a variety of industries. Recent acquisitions and new loyalty program initiatives are boosting sales and earnings growth.

The company increased sales in 14 of the past 15 years, and improved EPS (earnings per share) by at least 10% every year during the past 15 years. Sales and earnings increased 12% during the past 12 months, and will likely rise more than 12% during the next 12 months.

Alliance Data received some good news recently. Activist investor ValueAct Capital Management disclosed that it has purchased a 6.8% stake in ADS. ValueAct intends to open dialogue with Alliance Data management and board members to discuss how to enhance shareholder value. The investment by ValueAct is good news for ADS shareholders.

ADS is undervalued after considering the company’s low PEG ratio of 0.96. The company’s balance sheet is strong with almost $1 billion in cash, and the company’s price-to-earnings ratio of 13.8 is a tad high, but acceptable. ADS will likely climb 55% and reach my 354.42 sell target within two years. Buy ADS at the current price.

By Michael Cintolo, Chief Analyst, Cabot Market Letter and Cabot Top Ten Trader
From Cabot Wealth Advisory 12/18/14 Sign up for Cabot Wealth Advisory—it’s free!

Market choppiness and selloffs are never fun, but as I’ve written many times, these selloffs make it easier to spot strength. If you have a company with a good, consistent growth story, and a chart that is not only resilient but relatively calm, it’s telling you big investors have been hesitant to dump any shares, and were likely adding to their stakes during the market downturn.

One stock that fills the bill is Alliance Data Systems (ADS), which I wrote about in Cabot Top Ten Trader two weeks ago. Here’s what I said in the issue:

“Alliance Data Systems is a behind-the-scenes company that has a great story and years of persistent growth. The firm is behind a ton of loyalty credit card rewards programs, private label retail credit cards and, because it collects mountains of user transaction data, a bunch of marketing services to clients as well. This is a global business, too; Alliance is behind the huge Air Miles program in Canada, for instance, in which more than two-thirds of that country’s households participate! And the reason more and more firms sign up with Alliance is because it works—studies have shown that customers using the rewards cards that Alliance services spend more than others. Organic growth here isn’t amazing—about 9% to 11% per year—but acquisitions help boost that figure, cash flow and margins are solid and the company isn’t shy about buying back its own stock (it’s bought back about 1.5% of its stock this year). Of course, if consumer spending tanks, business is likely to dry up, but earnings growth has been incredibly resilient for many years (including right through the 2008 bust), and analysts see 15% to 20% earnings growth for the next couple of years. It’s a good, easy to understand story.”

ADS has been in a big base since mid-March, with two big dips (one bottoming in May, one in October) that brought the stock down to 230. It rallied nicely after that October bottom, and, most interestingly, consolidated tightly during the market’s recent maelstrom. And now, after the past couple of days, it’s reaching toward its old high of 290.

With the market still so volatile, buying ADS is tricky. But, in general, a big, decisive push above 293 or so looks buyable, and you could even consider nibbling around here. In both cases, a stop in the 270 area (relatively tight, percentage-wise) should keep risk in check.

For more updates on Alliance Data Systems and to find out about additional momentum stocks featured in this week’s issue, consider taking a risk-free subscription to Cabot Top Ten Trader.

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