Discover Financial Services (DFS) reported its
first quarter earnings for fiscal year 2011 on March 22, beating
the Zacks Consensus Estimate substantially by 33 cents per share,
led by strong net interest income growth and lower loan loss
provisions, though partially offset by higher-than-expected
interest expenses.
Nonetheless, the investors’ reactions to the
better-than-expected results were quite optimistic on Wall Street.
This gets reflected in the upward price movement witnessed since
the earnings release. The confidence could be justified not only by
the fundamental improvement in the credit and profitability metrics
but also by the recent acquisition of the Student Loan Corp.
(SLC).
Below we will cover the results of the recent earnings
announcement, subsequent analyst estimate revisions and Zacks
ratings for the short-term and long-term outlook for the stock.
Earnings Report Review
It’s always encouraging to outperform estimates, particularly
when the difference is substantial enough to inject optimism into
the future. A quick look at the top line reveals extensive growth
across segments, including direct banking and payment service
volumes, whose pre-tax operating income surged year over year.
While Discover credit card volumes grew by 7% year over year on
higher consumer spending and merchant acceptance. Further, the
credit quality improved on the reduction in the loan loss reserve
rate, and as the credit card charge-off rate declined along with
the decline in the credit card loan delinquency rate in the first
quarter.
However, this significant growth was partially offset by
higher-than-expected expenses that grew 26% year over year, during
the reported quarter, reflecting increased marketing and
advertising spending, higher compensation expense and costs related
to The Student Loan Corporation acquisition.
(Our full coverage on the earnings is available here: Discover
Financial Outshines)
Earnings Estimate Revisions - Overview
Estimates have witnessed significant upward movement for
Discover since the earnings release. This means that analysts
expect continued improvement going forward. In fact, this
gives quite a valid reason to own a stock that benefits from
positive results and provides a scope for a rise in the future. The
earnings estimate details are deeply delved into below.
Agreement of Estimate Revisions
Given the exceptionally strong fundamentals, analysts are
excited not only by the way Discover has weathered the storm of the
financial downturn, but also the successful completion of the SLC
acquisition. Analysts, therefore, agree with the optimistic outlook
for Discover’s earnings.
As a result, we see below that out of 15 analysts in the last 30
days, 13 have increased their estimates for the second quarter of
2011, while only one of the analysts has lowered the same, which is
overall encouraging.
Moreover, looking into the fiscal year of 2011, all the analysts
have raised their estimates over the 30-day period. Likewise in
2012, 14 analysts out of 16 have raised their estimates on the
strong and improved performance in the first quarter, and better
outlook for the near term. However, only one analyst has lowered
its estimate over the 30-day period. This shows a positive outlook
for 2011 and 2012.
Magnitude of Estimate Revisions
Overall the last 30 days, earnings estimates have shown
extraordinary improvement, up from 50 cents to 63 cents in the
second and the third quarters of 2011, since the earnings release.
Likewise, estimates moved significantly upwards to $2.66 from $1.98
per share for fiscal year of 2011.
Further, in 2012, the estimates upped from $2.17 to $2.46 per
share. This overall looks promising, particularly, when so many
other stocks are experiencing a decline, analysts continue to value
Discover’s earnings at a considerable premium.
Discover on Positive Side
Discover has implemented several capital bolstering initiatives,
including equity and debt offers, which have supported the company
to strengthen its capital base.
Moreover, with the repayment of its $1.2 billion government
bailout loan in April 2010, Discover can divert its focus to
consumers and business, to achieve financial success. Increased
merchant acceptance, improved credit quality and continued growth
in direct banking is expected to augment the top- and bottom-line
growth going ahead.
Moreover, the SLC acquisition has fetched appreciation from the
market for management’s decision to enhance its already strong
student loan portfolio, thereby also adding to the competitive
strength.
However, risks related to the imposition of the CARD Act
regulation, now that it is being implemented in its totality, and
rating downgrades continue to hurt the operating leverage of
Discover. Overall though, fundamentally the company is poised to
grow significantly with its well-diversified business model and a
more favorable operating environment.
Moreover, the company’s extensive network, sound capital
position and cost containment initiatives will help accentuate
growth once the markets rebound to its historical highs.
Going forward, we expect healthy growth opportunities with
limited downside to the stock, which also justifies the recent
upgrade in our recommendation to Outperform from Neutral. Hence, we
are maintaining a Zacks #2 Rank, which translates into a short-term
Buy recommendation. Our long-term recommendation for the stock is
upgraded to Outperform.
Discover competes with Visa, Inc. (V),
Mastercard Incorporated (MA) and American
Express Company (AXP).
About Earnings Estimate Scorecard
Len Zacks, PhD in mathematics from MIT, proved over 30 years
ago that earnings estimate revisions are the most powerful force
impacting stock prices. He turned this ground breaking discovery
into two of the most celebrating stock rating systems in use today.
The Zacks Rank for stock trading in a 1 to 3 month time horizon and
the Zacks Recommendation for long-term investing (6+ months). These
“Earnings Estimate Scorecard” articles help analyze the important
aspects of estimate revisions for each stock after their quarterly
earnings announcements. Learn more about earnings estimates and our
proven stock ratings at
http://www.zacks.com/education/
AMER EXPRESS CO (AXP): Free Stock Analysis Report
DISCOVER FIN SV (DFS): Free Stock Analysis Report
MASTERCARD INC (MA): Free Stock Analysis Report
VISA INC-A (V): Free Stock Analysis Report
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