After Rising 210%, Discover Financial Stock Is Best Avoided For Now

[Updated 12/7/2020] Discover Financial Update

We believe there may be better places for your money than Discover Financial stock (NYSE: DFS) at the present time. DFS trades at $83 currently and is 9% ahead of its pre-Covid high in February. Also, DFS stock has gained 210% from the lows of $27 seen in March 2020, after the multi-billion dollar stimulus package announced by the U.S. government which has helped the stock market recover to a large extent. The stock is leading the broader markets by a huge margin (S&P 500 is up about 65% since March lows), as investors are optimistic about the growth in consumer demand over the coming months, leading to growth in outstanding credit card loans.

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 were negatively impacted due to a drop in consumer demand. While Discover beat the consensus estimates in its recently released Q3 results, it reported revenues of $2.7 billion – 6% less than the previous year. Notably, it has almost doubled its provision for credit losses to $4.6 billion for the first nine months on a year-on-year basis, to cater to the higher risk of loan defaults. However, as the economy inches towards normalcy, we expect the consumer demand and the loan repayment capacity of its customers to improve over the coming months. In view of the strong rally in Discover Financial Services stock since late March, we believe that the stock has little room for growth in the near future even after factoring in an expected improvement in demand despite the recent surge in the number of new Covid-19 cases in the U.S. Our conclusion is based on our detailed analysis of Discover Financial’s stock performance during the current crisis with that during the 2008 recession in an interactive dashboard analysis.

[Updated 10/08/2020] Discover Financial Stock Still Has Room To Grow

We believe that Discover Financial’s stock (NYSE: DFS) has a strong upside potential of 16% in the near term. DFS trades at $64 currently and it has lost 23% in value year-to-date. It traded at a pre-Covid high of $74 in February and is 14% below that level now. Also, DFS stock has gained 144% from the low of $26 seen in March 2020, after the multi-billion dollar stimulus package announced by the U.S. government has helped stock prices recover to some extent. That said, the stock is leading the broader markets by a wide margin (S&P 500 is up 50%), as investors are positive about the growth in consumer demand over the coming months, leading to higher transaction volumes and credit card loans. Despite a significant improvement in DFS stock since late March, we believe that the stock still has room to grow in the near future. Our conclusion is based on our detailed analysis of Discover Financial’s stock performance during the current crisis with that during the 2008 recession in an interactive dashboard analysis.

2020 Coronavirus Crisis

Timeline of 2020 Crisis So Far:

• 12/12/2019: Coronavirus cases first reported in China
• 1/31/2020: WHO declares a global health emergency.
• 2/19/2020: Signs of effective containment in China and hopes of monetary easing by major central banks helps S&P 500 reach a record high
• 3/23/2020: S&P 500 drops 34% from the peak level seen on Feb 19, as COVID-19 cases accelerate outside China. Doesn’t help that oil prices crash in mid-March amid Saudi-led price war
• Since 3/24/2020: S&P 500 recovers 50% from the lows seen on Mar 23, as the Fed’s multi-billion dollar stimulus package suppresses near-term survival anxiety and infuses liquidity into the system.

In contrast, here’s how DFS and the broader market performed during the 2007/2008 crisis.

Timeline of 2007-08 Crisis

• 10/1/2007: Approximate pre-crisis peak in the S&P 500 index
• 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
• 3/1/2009: Approximate bottoming out of the S&P 500 index
• 1/1/2010: Initial recovery to levels before the accelerated decline (around 9/1/2008)

Discover Financial vs S&P 500 Performance Over 2007-08 Financial Crisis

DFS stock declined from levels of around $17 in October 2007 (the pre-crisis peak) to roughly $5 in March 2009 (as the markets bottomed out), implying that the stock lost as much as 73% of its value from its approximate pre-crisis peak. This marked a sharper drop than the broader S&P, which fell by about 51%.

However, DFS recovered strongly post the 2008 crisis to about $12 in early 2010 – rising by 159% between March 2009 and January 2010. In comparison, the S&P bounced back by about 48% over the same period. 

Discover Financial’s Fundamentals in Recent Years Look Strong

Discover Financial revenues saw a growth of 52% from $7.9 billion in 2015 to $12 billion in 2019, mainly driven by growth in the credit card business. Further, the company’s net income improved from $2.2 billion to $2.9 billion, resulting in a strong EPS growth from $5.14 in 2015 to $9.09 in 2019. Further, the company’s Q2 2020 revenues were lower than the year-ago period, and the EPS figure for the quarter decreased from $2.32 in Q2 2019 to -$1.20 in Q2 2020 due to a sharp increase in provision for credit losses.

CONCLUSION

Phases of Covid-19 crisis:

• Early- to mid-March 2020: Fear of the coronavirus outbreak spreading rapidly translates into reality, with the number of cases accelerating globally
• Late-March 2020 onward: Social distancing measures + lockdowns
• April 2020: Fed stimulus suppresses near-term survival anxiety
• May-June 2020: Recovery of demand, with the gradual lifting of lockdowns – no panic anymore despite a steady increase in the number of cases
• July-October 2020: Poor Q2 results and lukewarm Q3 expectations, but continued improvement in demand, a decline in the number of new cases, and progress with vaccine development buoy market sentiment

Keeping in mind the trajectory over 2009-10 and because of the improvement in Discover Financial’s stock since late March, this suggests a potential recovery to around $74 (16% upside) once economic conditions begin to show signs of improving. This marks a full recovery to the $74 level Discover Financial’s stock was at before the coronavirus outbreak gained global momentum.

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