Earnings Preview: Discover’s Troubles With Its Non-Banking Segment To Continue To Be A Drag On Profits

Discover Financial Services (NYSE: DFS) is set to announce earnings for the first quarter of fiscal year 2017 on Tuesday, April 25th. The U.S. based payments company has seen the performance of its financing and payments services division diverge over the last couple of years. While the company’s personal, student, and home equity loans have done well in recent quarters, following its run ins with regulators its payment services revenues have declined.

The payments space is currently dominated by Visa and Master Card, while American Express dominates the high end customer market. Discover doesn’t have a large enough customer base to which it can easily market its services nor does it have the technological expertise and scale to be able to pitch highly secure and highly efficient payment processing services. According to the company management, this decline is largely because they have been disciplined with spending on consumer rewards points, leading them to miss out on transaction volume. But more likely, it is an outcome of a low number of co-branding partnerships and the lower presence of Discover as a payment option in many online transactions.  The company needs to keep pace with the rapidly evolving technologies in the online payment space as well as increase the number of partners it has. We expect the same trends to continue in the first quarter, which means that Discover’s overall pre-tax income might decline.

In the previous fiscal year, the company’s interest income increased by 8.4% but its interest expenses increased by 10.7%. Similarly, its revenue from payments services increased by 4.2% but its spending on reward points increased by 12.7%. Additionally, revenue from other services declined by 12.1%. Still, the company managed to get its operating costs to decline by close to 1%. In recent years, Discover has managed to grow its EPS despite no growth in net income by buying back a large number of its shares. We expect the same pattern to continue this quarter.

Have more questions about Discover? See the links below:

• How Much Did Discover’s Revenue & Net Profit Grow In The Last Five Years?
• How Much Can Discover’s Revenue Grow In The Next Five Years?
• What Is Discover’s Fundamental Value Based On Expected 2016 Results?
• How Has Discover’s Revenue Composition Changed In The Last Five Years?

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