DFS Discover Financial Services

Discover Financial Services (DFS) reported first-quarter 2014 earnings per share (EPS) of $1.31, which exceeded the Zacks Consensus Estimate of $1.25 per share. However, EPS decreased 1.6% from the year-ago quarter’s $1.33.

The year-over-year deterioration is largely attributable to decline in both the Direct Banking and Payments Services segment income. Net income allocated to common shareholders decreased to $618 million from $659 million in the year-ago quarter.

Discover Financial’s total revenue, net of interest expense, increased 4% year over year to $2.1 billion, beating the Zacks Consensus Estimate of $1.77 billion. The improvement came on the back of loan growth and higher net interest margin in the Direct Banking segment as well as growth in card sales volume. Net interest income also improved 11% to $1.56 billion, reflecting higher loan growth and an increase in net interest margin.

Total other income for Discover Financial decreased 11.5% from the prior-year quarter to $515 million.

On the other hand, total other expenses increased 4.1% to $784 million.

Segment Update

Direct Banking Segment

Discover Financial’s Direct Banking segment reported pre-tax income of $994 million, reflecting a 4% decline from the year-ago quarter. Revenues, net of interest expense, for the segment increased 5% to $94 million.

Discover card sales grew 3.4% year over year to $25.7 billion, mainly stemming from high spend transactors. Total loans improved 6% to $63.8 billion, boosted by a 5% increase in credit card loans, a 5% rise in private student loans and a 27% surge in personal loans. The company is also achieving solid returns on equity in the private student loans and personal loans businesses.

Other income decreased 12% year over year, primarily due to a decline in direct mortgage related income and an increase in rewards costs. Meanwhile, expenses increased 3% on higher headcount and a surge in information processing and other expenses.

Discover Financial’s credit card net charge-off rate declined to 2.32% from 2.36% in the year-ago quarter. Similarly, the over-30 days delinquency rate improved to 1.72% from 1.77%.

In addition, provisions for loan losses increased $111 million year over year to $270 million, reflecting a decline in reserve release. Reserve build during the quarter was $59 million, lower than $154 million in the year-ago quarter.

Payment Services Segment

Pre-tax income at Discover Financial’s Payment Services segment declined 40% year over year to $28 million. Revenues in the segment, in first-quarter 2014, decreased 9% year over year reflecting a decline in transaction processing margins from PULSE.

Payment Services transaction dollar volume rose 4% from the year-ago quarter to $50.8 billion. Meanwhile, the transaction dollar volume from PULSE increased 5% year over year.

Financial Position

Discover Financial had total assets worth $79.6 billion as of March 31, 2014, indicating a rise from $79.3 billion as of Dec 31, 2013. Total equity stood at $11.0 billion at the end of March 2014, up from $10.8 billion at the end of Dec 2013. Book value per share was $23.53 as on March 31, 2014, compared with $22.89 as of Dec 31, 2013.

Return on equity stood at 23% for the first quarter of 2014. Tier 1 common capital ratio at the end of the first quarter of 2014 was 14.9%, up 60 bps sequentially. With the completion of the inaugural CCAR stress test, Discover Financial now targets Basel III Tier 1 common ratio of 11%.

Share Repurchase Update

During the reported quarter, Discover Financial repurchased 5.5 million shares worth $305 million, leading to a sequential decline of 1% in shares outstanding.

On April 16, 2014, Discover Financial authorized a $3.2 billion share repurchase program that will replace the $2.4 billion share repurchase plan authorized in March 2013. This new program is slated to expire on April 15, 2016.  

Dividend Update

On April 16, 2014, the board of Discover Financial increased its quarterly cash dividend by 20% to 24 cents per share. The increased dividend is payable on May 22, 2014 to shareholders of record as of May 8, 2014.

Our Take

Discover Financial successfully surpassed our earnings and revenue expectations. However, earnings declined year over year mainly on account of soft performance across its segments.

The company witnessed growth across its loan businesses. Discover Financial is also piloting its student loan consolidation product, which will be launched later this year. Also, the company is slated to implement its core banking system that is expected to assist the direct checking product launch this year.

The company's prudent marketing and capital deployment initiatives are helping it move toward its long-term goals. Management launched Discover it in 2013 that drove new account growth, added free FICO scores on statements and is up for significant product enhancements. Moreover, the recent capital deployment initiatives (dividend hike and share repurchase authorization) are expected to bolster investor sentiment.

Zacks Rank

Currently, Discover Financial caries a Zacks Rank #3 (Hold). Some better-ranked stocks in the financial services space include Capital One Financial Corporation (COF), World Acceptance Corp. (WRLD) and Tree.Com, Inc. (TREE). All three stocks carry a Zacks Rank #2 (Buy).
 

 
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