Discover Financial Stock To Miss The Earnings Estimates In Q1?

DFS: Discover Financial Services logo
Discover Financial Services

Discover Financial (NYSE: DFS) is scheduled to report its fiscal Q1 2021 results on Wednesday, April 21 (after the market closes). We expect Discover Financial to top the expectations for revenues, while the earnings are likely to remain below the consensus estimates. While the credit card giant managed to outperform the consensus estimates for revenues and earnings in each of the last two quarters, its top-line suffered in 2020, mainly due to a 4% y-o-y drop in the credit card business. The company is heavily dependent on the credit card business as the segment generates roughly 76% of the total revenues. The drop was mainly driven by lower consumer spending levels and interest rate headwinds due to the impact of the Covid-19 crisis. That said, the consumer spending levels have seen some recovery over the recent months. Further, DFS has reduced its provisions for loan losses over the last two quarters on a sequential basis, boosting its profitability figures. We expect the same trend to drive the first-quarter FY2021 results as well.

Our forecast indicates that Discover Financial’s valuation is around $95 per share, which is 7% below the current market price of around $102. Look at our interactive dashboard analysis on  Discover Financial’s pre-earnings: What To Expect in Q1? for more details. 

(1) Revenues expected to edge pass the consensus estimates in Q1

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Trefis estimates Discover Financial’s fiscal Q1 2021 revenues to be around $2.83 billion, slightly above the $2.77 billion consensus estimate. Discover Financial’s total revenues of $11.1 billion for the full year 2020 were 3% lower than the 2019 figure. This was mainly due to a 4% y-o-y drop in the credit card segment. The segment struggled due to lower outstanding card loans, a drop-in card purchase volumes, and lower net interest margin on the credit card loans – e.g. outstanding credit card loans declined by 2% y-o-y to $71.4 billion compared to a CAGR of 8% over 2016-2019. The outstanding card loans and purchase volume are linked to the consumer spending levels, which have seen some recovery over the recent quarters. We expect the same momentum to continue in the first quarter of FY2021.

Although the lower interest rate environment is unlikely to see a swift revival to the pre-Covid-19 levels – the Fed has maintained its benchmark rate near zero (as per the March 17th update), we expect the consumer spending levels to further improve over the subsequent quarters with expected improvement in the economy. This is likely to benefit DFS’ revenues, enabling them to touch $11.5 billion in FY2021. Our dashboard on  Discover Financial’s revenues offers more details on the company’s segments.

2) EPS likely to miss the consensus estimates

Discover Financial’s Q1 2021 adjusted earnings per share (EPS) is expected to be $2.64 per Trefis analysis, almost 6% below the consensus estimate of $2.81. The company’s profitability figures suffered in 2020 – adjusted net income decreased 62% y-o-y to $1.1 billion. This was mainly driven by a 59% jump in provisions for loan losses from $3.2 billion to $5.1 billion, to compensate for the higher risk of loan defaults. Further, its operating expenses as a % of revenues increased from 38.3% to 40.8% driven by higher compensation costs. This resulted in a drop in the EPS figure from $9.09 to $3.60. That said, the company decreased its provisions over the last two quarters, suggesting some improvement in the perceived loan repayment capability of its customers. We expect the same trend to continue in the FY2021 Q1 results. 

As more and more people receive the Covid-19 vaccination and the economic conditions recover, the loan repayment capability of Discover’s customers is likely to improve. It will likely result in a favorable drop in the provisions for loan losses, boosting the profitability figures for the year. Overall, it will enable DFS to report an EPS of around $8.98 in FY2021.

(3) Stock price estimate 7% lower than the current market price

Going by our Discover Financial’s valuation, with an EPS estimate of around $8.98 and a P/E multiple of just below 11x in fiscal 2021, this translates into a price of $95, which is 7% below the current market price of around $102.

Note: P/E Multiples are based on Share Price at the end of the year and reported (or expected) Adjusted Earnings for the full year

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