Discover Financial Services Earnings Preview: Payment Services Should Drive Results

Discover Financial Services (NYSE:DFS) is scheduled to report earnings for the second quarter of 2014 on Tuesday, July 22. ^[1] For the upcoming quarterly results, we expect the banking business to continue to drive the company’s growth. On the other hand, the payments division is expected to exhibit only moderate growth due to subpar consumer spending sentiment in the U.S. during the period.

In the previous quarter’s earnings, Discover reported a 6% increase in total loans. Its card sales volume grew 3% over the prior year, driven mostly by high-spending consumers. ^[2]

We have a price estimate of $60 for Discover’s stock, which is slightly below the market price.

See our complete analysis of Discover Financial here

Growth in Credit Card Loans While the Risk for Company Declines

Discover operates a closed loop network model, wherein it directly issues credit cards to its customers. Interest from these credit card loans brings nearly 60% of the company’s revenues and is thus a highly important factor in the company’s performance. According to recently released data by the company, average loans grew by about 4% in the April-June period . ^[3]

The company’s 30-day delinquency rate – the percentage of total loans that are past due – has seen a decline of about 10 basis points to 1.6% since last quarter’s earnings. The charge off rate, which is the percentage of loans that are considered nonredeemable, has been constant at around 2.3% as in the previous quarter. A decline is a good sign, meaning the company has fewer bad loans on its books. This is more or less in keeping with the industry-wide trend this quarter. ^[4]

Economic conditions are also a prime determinant of how credit card companies will perform. The U.S. economy continues to show tepid growth. In the first quarter of 2014, GDP contracted by 2.9% as compared to the 2.6% growth rate in the last quarter of 2013. ^[5] On the positive side, unemployment has come down over the last year. With the addition of 288,000 jobs, the unemployment rate improved to 6.1% in June. Earlier it had declined to 6.3% in April from a high of over 7% last year. ^[6]

Economic indicators such as personal consumption expenditures (PCE), personal income and savings also drive growth for credit card companies. According to the Bureau of Economic Analysis, personal income increased 0.4% to $58.8 billion in May 2014 over the previous month and the disposable personal income (DPI) increased to $55.6 billion from $50.8 billion during the same period. Personal savings as a percentage of disposable personal income was 4.8%  in May, compared with 4.5%  in April.  ^[5] Personal consumption expenditures (PCE) also increased $18.3 billion, or 0.2% as compared to an increase of just $2.3 billion in April. ^[7]  An increase in disposable income and expenditures is a good sign, but a simultaneous higher savings rate points towards more restrained levels of consumer spending.

We expect the income from credit card loans to improve due to lower delinquency rates, but at the same time lower consumer spending sentiment is likely to impact the growth in loans. For Discover, second quarter growth should be in the mid-single digits as reported in the last quarter.

Direct Banking Business to Continue Growing

In addition to the credit card and payments services, Discover also offers student and personal loans, and deposit products. The division has gained significance of late, especially since the company acquired Citigroup’s student loans business in 2011. In the previous quarter, Discover reported a 5% increase in student loans and a 27% increase in personal loans over the prior year.

We will be watching the upcoming earnings result for this business line very closely as we expect the growth momentum to carry forward in the second quarter results.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)
Get Trefis TechnologyDiscover Financial Ser

1. Discover Financial Services Announces Second Quarter 2014 Earnings Release and Conference Call, Investor Relations [↩]
2. Discover Financial Services’ CEO Discusses Q1 2014 Results – Earnings Call Transcript [↩]
3. Company 8K SEC Filing, July 15 [↩]
4. Delinquency rates fall at Major U.S. Banks in June, Reuters [↩]
5. News Release June 25 2014, Bureau of Economic Analysis [↩] [↩]
6. Bureau of Labor Statistics [↩]
7. Personal Income and Outlays, May 2014 Bureau of Economic Analysis [↩]