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Discover: A Cleaner Play On The Consumer Recovery
Sometimes it feels as though Congress and federal regulators are trying to bleed out major banks through dozens and dozens of regulatory papercuts. On top of that, there is still a lot of overheated rhetoric about the "evils" of large banks that hearken back to the populist movements of the late 19th century. That may all be an advantage for Discover Financial Services (NYSE:DFS), then, as this relatively purer play on credit cards may have fewer restraints on its day-to-day operations.
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A Solid Recovery Continues
Like its banking cousins, Discover is continuing to benefit from a much-improved credit environment and that is funneling through to the bottom line. Growth was not necessarily all that impressive in its own right, though. Total revenue rose about 3% from last year (or about 4% sequentially), fueled by a 2% rise in net interest income (up 4% sequentially). Within that, card sales volume was up 7%, but credit card loans were down 3% while total loans rose on higher student loan numbers.
Credit was once again a good story. Write-offs dropped almost a full point sequentially and more than three points on a year-over-year basis. That fueled a lot of the outperformance this quarter, as the company reversed a year-ago loss and beat the average estimate by a wide margin.
Interestingly, fee income is going nowhere fast at Discover. That is interesting as Discover "under-fees" its customers relative to the likes of American Express (NYSE:AXP) or Capital One (NYSE:COF), and this would seem to be an opportunity for growth in the future. On the other hand, with regulators looking to hammer the fee income of companies ranging from AmEx to Mastercard (NYSE:MA) to US Bancorp (NYSE:USB) to Visa (NYSE:V), maybe Discover's low fee revenue is a point of positive differentiation.
Where to from Here?
As a company that has historically relied upon securitization for part of its funding, Discover has to be seen as keenly interested in the credit markets getting back to normal. Then again, the company's current net interest margin is not all that bad, so its not a pressing problem.
Looking more broadly, there are still a lot of growth avenues for Discover to exploit. Discover's closed-loop system suggests it can never be as big as Visa or Mastercard, but that does not mean it cannot outgrow AmEx. (For more, see 7 Factors For Comparing Credit Cards.)
Likewise, there are ample opportunities in other financial services. Discover has moved into student lending and the seemingly unending rise in the cost of college suggests that that market isn't going away any time soon. Even more promising, though, might be a mobile payment system that the company is working with Verizon (NYSE:VZ) and AT&T (NYSE:T) to develop.
The Bottom Line
At nearly two times book value and about 10 times forward earnings, Discover does not necessarily look dirt-cheap. But then, that's still cheaper than AmEx. What's more, on a return-on-equity basis, Discover does look quite a bit more interesting. Although analyst expectations for Discover are not all that robust right now, the company's improving credit quality and the overall revival of the economy should bode well for the next couple of years. That said, that relatively slow growth in net interest income demands further watching, as growth from reserve releases won't go on forever. (For more, see Investing In Credit Card Companies.)
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A Solid Recovery Continues
Like its banking cousins, Discover is continuing to benefit from a much-improved credit environment and that is funneling through to the bottom line. Growth was not necessarily all that impressive in its own right, though. Total revenue rose about 3% from last year (or about 4% sequentially), fueled by a 2% rise in net interest income (up 4% sequentially). Within that, card sales volume was up 7%, but credit card loans were down 3% while total loans rose on higher student loan numbers.
Credit was once again a good story. Write-offs dropped almost a full point sequentially and more than three points on a year-over-year basis. That fueled a lot of the outperformance this quarter, as the company reversed a year-ago loss and beat the average estimate by a wide margin.
Interestingly, fee income is going nowhere fast at Discover. That is interesting as Discover "under-fees" its customers relative to the likes of American Express (NYSE:AXP) or Capital One (NYSE:COF), and this would seem to be an opportunity for growth in the future. On the other hand, with regulators looking to hammer the fee income of companies ranging from AmEx to Mastercard (NYSE:MA) to US Bancorp (NYSE:USB) to Visa (NYSE:V), maybe Discover's low fee revenue is a point of positive differentiation.
Where to from Here?
As a company that has historically relied upon securitization for part of its funding, Discover has to be seen as keenly interested in the credit markets getting back to normal. Then again, the company's current net interest margin is not all that bad, so its not a pressing problem.
Looking more broadly, there are still a lot of growth avenues for Discover to exploit. Discover's closed-loop system suggests it can never be as big as Visa or Mastercard, but that does not mean it cannot outgrow AmEx. (For more, see 7 Factors For Comparing Credit Cards.)
Likewise, there are ample opportunities in other financial services. Discover has moved into student lending and the seemingly unending rise in the cost of college suggests that that market isn't going away any time soon. Even more promising, though, might be a mobile payment system that the company is working with Verizon (NYSE:VZ) and AT&T (NYSE:T) to develop.
The Bottom Line
At nearly two times book value and about 10 times forward earnings, Discover does not necessarily look dirt-cheap. But then, that's still cheaper than AmEx. What's more, on a return-on-equity basis, Discover does look quite a bit more interesting. Although analyst expectations for Discover are not all that robust right now, the company's improving credit quality and the overall revival of the economy should bode well for the next couple of years. That said, that relatively slow growth in net interest income demands further watching, as growth from reserve releases won't go on forever. (For more, see Investing In Credit Card Companies.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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