Buy, Sell, Or Hold Discover Financial At $40?

by Trefis Team
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Despite almost 47% growth in Discover Financial’s (NYSE: DFS) stock since hitting a low of $27 on March 23, as compared to the 27% growth in the S&P 500, we believe Discover Financial still has significant upside potential. Why is that? The key is the company’s stock is still about 52% lower than it was at the beginning of 2020 and a little over 40% lower than it was at the end of 2016. Our dashboard, ‘What Factors Drove 23.6% Change In Discover Financial Stock Between 2016 And 2019?‘, provides the key numbers behind our thinking, and we explain more below.

Discover Financial’s revenues have grown roughly by 26% from 2016 to 2019, which translated into a 24% growth in Net Income.  However, earnings growth, on a per share basis was a much higher 58%, partially driven by massive share buy-backs and partially due to drop in effective tax rate from 2018. Specifically, the company has invested about $5.6 billion in repurchases in the last three years, resulting in about 21% lower outstanding shares. While Discover Financial did have about $21.9 billion in cash and cash equivalents as of the last report, we believe it will likely be challenging for the company to sustain this level of buybacks.

Further, Discover Financial’s P/E ratio declined by 21% from about 11.7x at the end of 2016 to 9.3x at the end of 2019. While Discover Financial’s P/E is down to about 4.5x now, which is at the lowest level seen over the recent years, there is a possible upside for Discover Financial’s multiple when compared to levels seen in the past years – P/E of 9.3 at end of 2019, and 7.3x as recent as in late 2018.

How Is Coronavirus Impacting Discover Financial’s Stock?

The coronavirus outbreak has had a sizable impact on Discover Financial’s stock as people are focused almost entirely on essentials rather than discretionary and leisure expenses due to economic uncertainty. It means they are not meeting friends and colleagues for drinks, lunch, or dinner, not going to movies, amusement parks, vacation trips, etc. As the credit card giant is heavily dependent on its credit card business (which contributed around 76% of its revenues in 2019), in the wake of a global economic meltdown and widespread panic, the credit card revenues could be negatively impacted due to a drop in consumer demand and loan default. While the Q1 results saw some increase in the revenues, we believe Discover’s Q2 results will confirm this reality with a drop in both credit card revenues and transaction volume as well as an increase in loan losses. It is also likely to accompany a lower Q3 as-well-as 2020 guidance.

However, if there are signs of abatement of the crisis by the time Q2 results are announced, the company’s stock could see an upturn. Further, DFS’ 52% decline since the beginning of 2020 has under-performed the S&P 500 (-12%) and its peer American Express’ 30% drop over the same period. In the current scenario, we believe Discover Financial’s stock is likely to remain around its current levels, with good upside potential post coronavirus.

Our dashboard forecasting US COVID-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus. Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a more complete macro picture. It complements our analyses of Coronavirus impact on a diverse set of Discover Financial’s peers. The complete set of coronavirus impact and timing analyses is available here.

Discover Financial has under-performed its peer American Express since the beginning of 2020. To understand it better, we have analyzed the reason behind movement in American Express’ stock over 2016 and now.


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