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