Discover Financial Earnings Preview: Sales Growth And Provisions In Focus
Discover Financial ( DFS ) is scheduled to report earnings for the fourth quarter of 2013 on Thursday, January 23. The company is likely to gain from strong 2013 holiday season retail sales in the U.S., which were up 3.9% according to the National Retail Federation. American Express ( AXP ) was able to capitalize on this trend as its net income for the fourth quarter of 2013 doubled the amount reported in 2012. Last week, AmEx reported a 9% increase in U.S. cardmember spending for the December quarter, leading to an 8% revenue gain. We expect Discover to replicate its peer's top-line growth.
However, the bottom line might be affected by lower expectations of recoveries on well-aged charge-offs (loans that are considered unredeemable). Discover did not sell off any of its charged-off accounts after the recession and thus benefited as the U.S. economy improved with strong recoveries on its inventory of charge-offs. However, in the coming years, the company does not expect the same level of recoveries and is making adjustments to its reserves. During the last quarter, Discover reported a $197 million increase in provisions for loan losses, which offset a 3% increase in revenues, leading to an 8% decline in net income.
Our $47 price estimate for Discover Financial implies a discount of 15% to the current market price.
See our complete analysis of Discover Financial here
Online Spending Spree
Data released by the U.S. Department of Commerce suggests that consumers are more inclined to spend; personal saving as a percentage of disposable personal income has gone down from 6.6% in the fourth quarter of 2012 to 4.9%. The improving job environment, which saw the unemployment rate drop below 7% in December, is also contributing. Personal consumption expenditures were up 3% year-on-year through October and November, following a 3% increase in disposable personal income through the third quarter. Discover's own U.S. spending monitor also indicates that consumer confidence is at its highest level since July.
E-commerce was one of the biggest drivers for holiday season sales as Americans preferred to shop from their homes rather than brave the cold weather. Amazon ( AMZN ) reported a record holiday season for its annual membership program, Amazon Prime, with more than more than 426-items sold per second through Cyber Monday. More than 1 million customers registered for the company's services in December. This increase in online shopping helped mitigate the effects of a 15% decline in customer traffic through December. Strong online sales portend good results for card companies like Discover, Visa ( V ) and MasterCard ( MA ) as their cards are widely used for online transactions.
Provisions To Increase
Following the 2008 recession, credit card customers across the U.S. started paying off their loans quickly, in order to avoid staying in debt during the financial crunch. The delinquency rate on credit card loans for all commercial banks in the U.S. dropped from 6.76% in the second quarter of 2009 to 2.52% in the second quarter of 2013. In the same period, the charge off rate on credit card loans for the top 100 banks ranked by assets in the country dropped from 9.59% to 3.53%.
Discover maintained lower delinquency and charge off rates than the credit card industry as a whole; the delinquency rate for loans over 30 days due was 4.92% in 2009 but dropped to 1.75% in 2012, while the net principal charge off rate dropped from 7.45% in 2009 to 2.29% to 2012. This was the primary reason for the elevated recoveries on charged-off accounts; provisions for loan losses were around 2.7% of average credit card loans in 2008 but increased to over 6.5% in 2010 before dropping to 1.55% in 2012.
Discover's charge-off rate hit a low of 2.05% in the third quarter, but the credit card delinquency rate for loans over 30 days past due date increased 9 basis points from the prior quarter to 1.67%. The company expects the recovery rate to decline in the coming years and is making adjustments to its reserves for loan losses. We expect the provisions to reach pre-recession levels in the next three years.
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