Discover Downgraded to Neutral - Analyst Blog
29 Novembre 2011 - 1:15PM
Zacks
We have downgraded our recommendation on Discover
Financial Services (DFS) to Neutral based on a weak
momentum in the earnings outlook. The company reported
third-quarter 2011 earnings per share of $1.18, significantly ahead
of both the Zacks Consensus Estimate of 91 cents and 47 cents
recorded in the year-ago quarter.
Discover’s credit card sales volume has been witnessing modest
improvement owing to improved consumer spending and credit quality
trends. In the first nine months of 2011, card sales volume climbed
8% year over year to reach $75.1 billion.
Improved credit trends have helped in substantial release of
credit loss reserves, a part of which has been reinvested for
operational growth. Recently, the company has been focusing on
increasing its card acceptance through various alliances.
The agreement with Banco Popular de Puerto Rico commercial bank
is likely to expand Discover card acceptance through millions of
card members and billions in spending on the Discover and Diners
Club International networks. The deal with WorldPay is also
expected to augment the acceptance of Discover and Diners Club
cards, while the agreement with NETS Inc. will not only increase
the usage of the PULSE network for PIN debit transactions, but also
substantially increase the acceptances of Discover’s PULSE, Diners
Club and Discover Cards in the U.S.
Additionally, Discover continues to explore healthy
opportunities for inorganic growth as well. The Student Loan Corp.
(SLC) acquisition comes in line with the company’s long-term goal
of bolstering its private student loan portfolio, which has grown
steadily over the past three years when many others had to
discontinue the business altogether. Furthermore, the agreement to
acquire Home Loan Center, a subsidiary of Tree.com,
Inc. (TREE), has added a residential mortgage component to
Discover's direct-to-consumer banking business.
Discover has also implemented several capital bolstering
initiatives, including equity and debt offering, which have
supported the company in achieving a strong capital base. Besides,
the proficient cost containment measures have aided substantial
reduction in loan loss provisions, improvement in delinquency and
net charge-off rates and moderation in interest expenses, thereby
prompting significant enhancement in bottom-line growth over the
past several quarters. In fact, in the third quarter of 2011,
Discover’s credit card delinquency rate hit the lowest in 25 years
and the charge-off rate fell below 4% for the first time since
2007.
However, Discover’s competitors in the credit card business such
as MasterCard Incorporated (MA) and Visa
Inc. (V) have substantially larger scales of operation
than the company, thereby posing ample risk on the operational
front. Not only do the arch-rivals have relatively stronger global
presence and brand names, but they also own exclusive contracts
with many financial institutions, thereby limiting Discover’s
business opportunities with such institutions.
Moreover, we expect continued adverse impact of the
implementation of CARD Act provisions along with an anticipated
increase in the volume of promotional rate offers to unfavorably
impact credit card yield in 2011, although we believe that it will
be partially offset by continued improvement in interest
charge-offs. A decline in credit card yield, together with the
addition of lower rate student loans from the acquisition of SLC
would lead to a further reduction in the net interest margin.
Moreover, Discover incurs considerable expenses in order to
compete with other credit card issuers to attract and retain
customers and increase card usage. Discover’s profits are largely
tapered due to the company’s higher-than-expected advertising and
marketing expenditures.
Besides, employee compensation and benefits expenses are showing
an increasing trend, on the back of
the SLC acquisition and
staff additions. Additionally, in June 2011, the company agreed to
settle eight class-action lawsuits related to its marketing
policies, which is likely to considerably add to expenses, although
the settlement is yet to be approved by the court.
The Zacks Consensus Estimate for Discover’s fourth-quarter 2011
earnings is currently 90 cents per share, up about 40% year over
year. For full year 2011, the Zacks Consensus Estimate stands at
$4.02 per share, up by a substantial 230% from
2010.
The company
currently caries a Zacks #3 Rank, which translates into a
short-term Hold rating.
DISCOVER FIN SV (DFS): Free Stock Analysis Report
MASTERCARD INC (MA): Free Stock Analysis Report
TREE.COM INC (TREE): Free Stock Analysis Report
VISA INC-A (V): Free Stock Analysis Report
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