Upside / Downside Case for Discover Financial Services

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Discover Financial Services ( DFS ) is a direct banking and payment services company that offers credit cards, student loans, personal loans and deposit products. It operates the Discover Network, the PULSE Network ("PULSE"), its automated teller machine ("ATM") and Diners Club International (Diners Club). It competes with other financial firms like Capital One ( COF ), American Express ( AXP ), Visa ( V ) and MasterCard ( MA ).

The credit card segment is most valuable for Discover and accounts for almost 56% of the $20.99 Trefis price estimate for Discover 's stock. Below we look at the key driver of the credit card segment which presents an upside or downside potential to our price estimate of Discover.

10% Upside - Increase in Average Credit Card Loans

The average credit card loan outstanding for Discover has been increasing in the past couple of years except for 2010. The increasing trend should continue primarily because of the growing card usage and declining paper based transactions. We expect the average credit card loans to grow at an annual rate of 5% and reach $64 billion by the end of our forecast period. However, there could be 10% upside to our price estimate of Discover if it grows more rapidly and touch $80 billion. See these forecasts in the below chart.

10% Downside - Higher than Estimated Provisions for Losses

Financial companies like banks, credit cards companies and insurers make provision for losses based on the composition of a firm's credit portfolios, their probability of default, the economic environment and the allowance for credit losses already established.

Discover's provisions as a percent of average credit card loan outstanding declined from 10% in 2009 to 6.4% 2010 due to a reduction in the loan loss reserve rate and a decline in the level of net charge-offs.

We expect it to decline further to about 4% of average credit card loans outstanding. There is around 10% downside to our price estimate if the decline is less than our estimate and provisions declined to 4.5% from its current level of 6.4% by the end of our forecast period.

See our full analysis of Discover Financial Services



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: AXP , COF , DFS , MA , V

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