Electronic payment processor in the US, Discover
Financial Services (DFS) is scheduled to release its
second quarter results before the market opens on June 23, 2011.
The Zacks Consensus Estimate for the second quarter is 66 cents per
share, representing about 100% growth over the year-ago
quarter.
Following the first quarter trends, higher consumer spending and
gradual rise in merchant acceptance along with improved credit
quality and The Student Loan Corp. (SLC) acquisition are further
expected to boost volumes and rev up company’s position. However,
increased expenses, primarily on marketing and advertising, and
regulatory provisions may continue to limit the desired upside.
Previous Quarter Performance
Discover’s first quarter earnings came in at $465 million or 85
cents per share, dramatically ahead of the Zacks Consensus Estimate
of 52 cents per share. The prior-year quarter posted a net loss of
$104 million or 19 cents per share.
Net income allocated to common shareholders also surged to $459
million or 84 cents per share from a loss of $122 million or 22
cents per share, during the reported quarter. Results included
contribution from SLC acquisition.
Total revenue, net of interest expense, increased 2.5% year over
year to $1.73 billion, also exceeding the Zacks Consensus Estimate
of $1.06 billion. Discover’s deposit balances originating from
direct-to-consumer and affinity relationships increased $7.0
billion from the year-ago quarter to $21.8 billion.
Provisions for losses dramatically declined $969 million year
over year to $418 million, reflecting lower charge-offs and a
reduction in the allowance for loan losses. However, expenses
escalated 26% year over year to $115 million, resulting from
increased advertising and promotional marketing spending, along
with the costs related to the acquisition of SLC.
Agreement with Analysts
Ahead of the earnings release, we see some upward movement in
analyst estimates over the past 30 days. A similar trend has been
noticed over the past 7 days. Hence, the estimate revision trends
and the magnitude of such revisions justify a positive sentiment on
the street.
In the last 30 days, 4 of the 16 analysts have revised their
estimates upward for the second quarter of 2011, while three of the
15 analysts increased their estimates for fiscal 2011. However, no
downward revisions were witnessed, overall reflecting a slight
movement towards positive direction. This implies that the analysts
do not foresee any significant downward pressure on the
results.
Meanwhile, the positive approach towards Discover also gives
scope for some positive surprises in the first half of 2011,
particularly, on achieving better clarity on the potential effects
of the ongoing regulations, primarily which requires reduction in
interchange fee that are paid on debit transactions.
Moreover, the recent 200% dividend increment along with the
authorization of the new $1.0 billion share repurchase program
reflects Discover’s efficient capital deployment strategies,
healthy balance sheet and strong cash flows.
Magnitude of Estimate Revisions
In the last 90 days, there have been significant revisions in
the earnings estimate following the first quarter results. As a
result, earnings per share increased by 13 cents to the current
level of 66 cents for the second quarter, while the same grew by 63
cents to $2.75 for 2011.
Furthermore, earnings per share surged by 34 cents to the
current estimate of $2.55 for 2012. However, this trend, negative
earnings growth projection for 2012 over 2011, reveals a cautious
outlook in the analysts’ opinion given the lack of clarity once the
regulation will be in full implementation by the next fiscal.
Surprise
Going by past trends, we have a slightly mixed opinion on
Discover exceeding estimates, given the uncertain regulatory
environment hanging around Discover and its peers. The company’s
reported earnings per share exceeded its expectations in all of the
last four quarters and has a positive four-quarter average surprise
of 86.29%.
Our Take
Since its inception in 1986, Discover has grown to become one of
the largest card issuers in the US and a leading innovator and
initiator of change in the credit card industry. Discover has also
experienced continued growth in its direct-to-consumer banking
business by leveraging its low cost infrastructure, brand, credit
management and marketing capabilities.
Moreover, the SLC acquisition is expected to shore up the
bottom-line from the first year of purchase, carrying an earnings
increment of at least 9 cents per share in 2011 itself.
While the acquisition marks the company’s strong financial and
capital leverage, it also coincides with Discover’s long term goal
of bolstering its private student loan portfolio, which recorded
steady growth over past three years when many others fizzled out.
We expect these positives to continue and aid the company to
improve its top line.
Discover has not only been growing steadily but has also been
returning incremental wealth to its investors by deploying its
capital resourcefully, which again reflects its growth potential
going forward.
However, the prime reason of concern hovers around the
regulations that limits the desired upside. The CARD Act of 2009
requires the company to make fundamental changes to many of its
current business practices, including marketing, underwriting,
pricing and billing.
Further, the Dodd-Frank Act that was enacted in July 2010 has
finally axed the card companies by slashing the interchange fees on
debit card transactions by about 72% over 2009 prices.
Particularly, card giants such as Discover, Visa
Inc. (V) and MasterCard Inc. (MA) are
reported to be the wary victims of the interchange fee cuts.
We expect the implementation of CARD Act provisions in 2011
along with an anticipated increase in the volume of promotional
rate offers to unfavourably impact credit card yield, although we
believe it will be partially offset by continued improvement in
interest charge-offs.
Nevertheless, the company’s extensive network, improved credit
quality, sound capital position and cost containment initiatives
will help accentuate growth over the long term.
The quantitative Zacks Rank for Discover is currently #3 with a
short-term Hold rating, indicating no clear directional pressure on
the shares over the near term.
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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