Discover Beats on Volume Growth - Analyst Blog


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Discover Financial Services ( DFS ) reported first-quarter earnings per share of $1.18, substantially ahead of the Zacks Consensus Estimate of 92 cents as well as 84 cents recorded in the year-ago quarter. Net income spiked 35.7% year over year to $631 million from $465 million. Net income allocated to common shareholders also surged to $624 million from $459 million in the year-ago quarter.

The surge in profits was buoyed by sales volume growth, complemented by higher interest income, reduced provision for loan losses and lower delinquency rates on account of improved credit quality. Results were also boosted by the escalated income from both direct banking and payment services business, which also drove the book value per share.

Total revenue, net of interest expense, increased 6.4% year over year to $1.84 billion. Net interest income also improved 11% year over year to $1.29 billion. However, total other expenses increased 13.8% year over year to $677 million.

Direct Banking Segment

The Direct Banking segment reported a pre-tax income of $962 million, reflecting a $285 million increase from the year-ago quarter. Discover card sales volume grew 7% year over year to $25.6 billion, primarily due to addition of new customers.

Total loans improved 9% year over year to $56.3 billion, boosted by an increase of $1.6 billion in credit card loans, $3.0 billion in private student loans (including purchase of a $2.4 billion loan portfolio in the fourth quarter of 2011) and $764 million in personal loans.

However, growth was partially offset by the sale of $698 million of federal student loans by Discover in the first quarter of 2012. Other income decreased 5% year over year, primarily due a purchase gain of $16 million related to the Student Loan Corporation acquisition in the first quarter of 2011.

The credit card net charge-off rate declined 289 basis points (bps) year over year and 17 bps from the prior quarter to 3.07%. Moreover, the over-30-days delinquency rate was at an all-time low of 2.22%, having improved substantially by 137 bps year over year and 17 bps sequentially, reflecting an overall better credit trend since the fourth quarter of 2009.

Besides, the provisions for losses declined 64% or $266 million year over year to $152 million, reflecting lower charge-offs. Reserve release was $226 million in the reported quarter, as opposed to $271 million in the year-ago quarter.

Additionally, expenses in the segment soared 15% year over year based on higher compensation and benefit expenses, investments in infrastructure, higher reserves related to litigation and growth initiatives and higher fraud costs.

Payment Services Segment

The Payment Services segment's pre-tax income grew 21% year over year to $52 million. Revenues were up $9 million, reflecting an increase in point-of-sale transactions on the PULSE network, which carry a higher margin. Moreover, expenses remained almost constant at the year-ago level, primarily due to lower marketing costs related to timing of programs, which offset the increase in compensation costs.

Payment Services dollar volume accelerated 8% from the year-ago quarter to $46.7 billion, reflecting higher PULSE, Diners Club International and third-party issuer volume.

Share Repurchase Update

On March 13, 2012, the board of Discover authorized a $2 billion share repurchase program dated to expire on March 22, 2014. The new share repurchase program replaced the previous $1 million program, which was set to expire in June 2013, but was terminated prematurely. During 2011, Discover had repurchased 18 million shares for $425 million under its old repurchase program.

Our Take

Discover has been generating exceptional card sales volume over the past few quarters, owing to improved consumer spending and credit quality trends. Moreover, operating performance in both segments was impressive, which contributed to the bottom-line growth. Besides, the company has a strong inorganic growth policy, which apart from boosting earnings also fosters portfolio diversification.

However, the expenses of Discover have been rising due to higher compensation and benefit expenses, infrastructure development and growth initiatives. Moreover, the company expects its litigation expenses to rise and has been strengthening its reserves for the same.

Nevertheless, the remarkable improvement in credit quality makes us optimistic about Discover's future earnings. Additionally, the company's extensive network, sound capital position and cost containment initiatives are expected to accentuate growth over the long term.

Discover competes with other card companies like MasterCard Inc. ( MA ) and Visa Inc. ( V ). Currently, the company caries a Zacks #1 Rank, implying a 'Strong Buy' rating in the short term.

DISCOVER FIN SV ( DFS ): Free Stock Analysis Report
MASTERCARD INC ( MA ): Free Stock Analysis Report
VISA INC-A ( V ): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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