Discover Financial Earnings Preview: What We’re Watching

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DFS: Discover Financial Services logo
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Discover Financial Services

Discover Financial (NYSE:DFS) is expected to report earnings for the fourth quarter of 2012 on Thursday, December 20th. The company, best known for its credit cards, has had a good year in 2012, branching out into verticals like mortgage and student loans. The diversification of operations along with growth in its core card business has inspired investor confidence as the stock has climbed by nearly 70% since the turn of the year. We believe the fourth quarter results will match the performance in the first nine months of 2012, our $38 price estimate for Discover Financial in-line with the current market price.

See our complete analysis of Discover Financial here

Credit Cards Lead The Way

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Credit cards are Discover’s most important revenue stream. Interest from credit loans account for 66% of its net revenues whereas discount fees charged from merchants accepting its cards account for another 16%. About 80% of the company’s gross profit is earned from credit loans and discount fees on credit cards.

Discover had been able to maintain a high single digit yield, around 9%, on its outstanding loans in the last two years as well as industry low delinquency rates. The average loans outstanding have been around $45 billion through the last three years. The company reported a year-on-year increase of $2 billion in credit card loans in the last quarter. With the Federal Reserve taking strong measures to stimulate the U.S. economy, we expect Discover’s average credit card loans outstanding to grow over the next few years. [1]

We also expect growth in transaction volumes in the coming years, Discover has seen a growth of 7% in transactions processed on the Discover network over the last two years and was able to maintain this rate through the first nine months of 2012. Our forecast accounts for a similar growth rate over the next few years based on the momentum that Discover has been able to gain and the company’s expansion in geographies outside the U.S. (Please refer to Discover Enters Russia En Route To $39 for more details)

Diversification Looks Good

Discover has been looking to diversify its operations, last September, it acquired Citigroup’s (NYSE:C) $2.5 billion student-loan portfolio and followed up the deal with acquisition of the Home Loan Center business from Tree.com, in June this year. At the end of the last quarter, the company reported a growth of 33% in private student loans over the nine months ending August along with a 60% growth in other loans. We expect a strong growth in student and other loans through the next few years.

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Notes:
  1. Fed Links Rates to Joblessness, Expands Bond Purchases, Bloomberg, 13th December, 2012 []