Related tickers: Discover Financial Services (NYSE:DFS), Capital One Financial Corp. (NYSE:COF)
As the US economy recovers, mainly thanks to the Federal Reserve’s quantitative easing program, some sectors of the economy have great opportunities ahead. One industry that can benefit from an improvement in the economy is the credit card business. The reason is straightforward: Household purchases account for 70% of the US economy. I am going to evaluate two banks/financial services companies that are in the credit card business and will largely benefit from the increase in private spending.
Worth Discover-ing
First of all, accounts acquisition costs fell in 2012 (mainly due to the possibility of acquiring new accounts online: Discover Financial Services (NYSE:DFS) IT product). As a second point, balance transfer offers are becoming a profitable component of its card growth strategy. The company charges a 3% fee for balance transfers.
Moreover, the company’s 30-day delinquency rates continue to decrease (it is expected they will reach 5%). Finally, new product developments, such as direct bank checking, could help the lending business have more information and lead to better lending decisions.
However, there are some risks that investors must weigh. Discover’s student loan program could pose a threat. TThe student loan business is experiencing regulatory changes, including increased scrutiny from the Consumer Financial Protection Bureau and potential bankruptcy law modifications. But Discover Financial Services (NYSE:DFS) is not changing its strategy amid those changes .
Also, the company will no longer market its product under the CitiAssist brand, having ended its agreement with Citigroup Inc (NYSE:C) in 2012 (45% of 2012’s originations were done through the CitiAssist brand). Another negative aspect is expense growth, which is estimated at $3.1 billion for 2013.
With this perspective, it looks like Discover Financial Services (NYSE:DFS) has a very good position to continue growing despite the aforementioned risks. Management is clear and following its strategy, and indicated that it will be more aggressive regarding capital return in 2013. Investors can expect share buybacks, and approximately $267 million in dividends.
A Capital idea
Capital One Financial Corp. (NYSE:COF) is a bank holding company with several products such as credit cards, home and auto loans, and banking products. Capital One’s market share for the credit card issuing business in 2011 was 7.13%.
The key aspect that can affect the company is the sale of its $7 billion Best Buy Co., Inc. (NYSE:BBY) portfolio to Citigroup Inc (NYSE:C). The sale will impact the company in 2014 and beyond:it is a reversal of the company’s intent to build in private label and it will hurt Capital One Financial Corp. (NYSE:COF)’s income (income contribution from the Best Buy portfolio represents about 4% out of the total).
That said, there are some positive characteristics that may pose opportunities for future growth. One of them is the company’s capitalization. The company is adequately capitalized; its Tier 1 common ratio is 11%. And it has posted some growth in the domestic card business:purchase volumes grew 9.4% year-over-year and the loss rate for this segment fell to 4.27%. Also, its commercial banking sector grew 13% year-over-year.
In this case, the negative aspects are a bit more poignant than the positive ones. As mentioned before, Best Buy Co., Inc. (NYSE:BBY)’s portfolio sale will negatively impact the company. The sale will also present a challenge regarding the sustained weakness in card demand that was previously noted by management. In 4Q12, total revenue declined primarily by higher card revenue suppression to $5.6 billion and asset yields decreased 0.52% to 7.36% from the previous quarter.
For the reasons stated above, I consider that between these companies, Discover Financial Services (NYSE:DFS) Financial looks most promising. Its card business is in an excellent position to grow further:it’s account acquisition costs fell, delinquency rates also decreased and it is developing new products that could generate more revenue. We have to add that it is currently undervalued if we compare its P/E ratio of 9.9 to Mastercard Inc (NYSE:MA)’s 24.3 and Visa Inc (NYSE:V)’s 25.6. Moreover, its PEG ratio is 0.89, against MasterCard’s 1.1 and Visa’s 1.2.
Damian Illia has no position in any stocks mentioned. The Motley Fool owns shares of Citigroup Inc (NYSE:C).
