We are maintaining our Outperform recommendation on
Discover Financial Services
) based on the consistent increase in its sales volumes along with
record-low delinquency and charge-off rates. The company's strong
inorganic growth policy and introduction of home loan products are
expected to boost revenues further and diversify the product
Discover reported second-quarter 2012 earnings per share of
$1.00, a penny ahead of the Zacks Consensus Estimate, but lower
than $1.09 recorded in the year-ago quarter. Discover delivered
nine quarters straight of positive earnings surprise with an
average of 51%.
Discover credit card sales volume reached an all-time high of
$100 million in 2011, owing to improved consumer spending and
credit quality trends. The trend continued in the first half of
2012, with sales volume of $51.7 billion, up 5.9% year over year,
primarily due to increase in the customer base.
The proficient cost-containment measures have aided substantial
reduction in loan loss provisions, improvement in delinquency and
net charge-off rates and moderation in interest expenses, thereby
facilitating significant enhancement in bottom-line growth.
In fact, in the third quarter of 2011, Discover's credit card
delinquency rate hit the lowest in 25 years and the charge-off rate
fell below 4% for the first time since 2007. Both rates continued
to decline in the first half of 2012 as well.
Moreover, the acquisition of Home Loan Center from
) has added a residential mortgage component to Discover's
direct-to-consumer banking business, thereby enabling it to launch
its subsidiary - Discover Home Loans. With the launch of this new
unit, Discover now offers commercial and Federal Housing
Administration loans with both variable and fixed rates.
However, Discover's competitors in the credit card business,
), have substantially larger scales of operation, posing ample risk
on the operational front. They not only have relatively stronger
global presence and brand names, but they also own exclusive
contracts with many financial institutions, thereby limiting
Discover's business opportunities with such
Further, Discover incurs considerable expenses in order to
compete with other credit card issuers to attract and retain
customers and increase card usage. Discover's profits are largely
tapered due to the company's higher-than-expected advertising and
Information processing and communications expenses, professional
fees, premises and equipment, and other expenses also increased in
the first half of 2012, thereby substantially increasing total
non-interest expenses. Further, the launch of Discover Home Loans
is expected to increase the operating expenses by about $35 million
per quarter from the third quarter of 2012.
Nevertheless, the company's extensive network, sound capital
position, stable ratings, rapidly expanding acceptances and cost
containment initiatives will help it accentuate earnings over the
Discover currently carries a Zacks #2 Rank (short-term Buy).
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