Capital One Financial: Don't Miss This Opportunity

| About: Capital One (COF)

It seems everybody is getting into financial services these days or at least expanding their offerings in the sector. Wal-Mart (NYSE:WMT) and American Express (NYSE:AXP) are offering debit cards and checking accounts together. eBay (NASDAQ:EBAY) and Discover Financial Services (NYSE:DFS) are trying to combine PayPal and the Discover card into a new kind of financial service. Not to be outdone, Capital One Financial (NYSE:COF) has decided to start opening brick and mortar banks that will offer financial services and coffee.

Is this headlong rush into new kinds of financial services good news for investors? The geniuses at the various companies involve hope all those new services will lead to increased cash flow and new revenues from fees. But are these hopes realistic? Will the expansion of retailers into finance and credit card companies into banking generate additional cash or not?

The numbers from Capital One seems to indicate that they just might be onto something. Capital One's revenues have grown by a little over $6 billion in the past two years from $16.08 billion in September 2010 to $22.31 billion on September 31st, 2012. The revenue from Discover Financial Services has grown as well, but not as fast. Discover's revenue grew from $5.96 billion in November 2008 to $8.841 billion on August 31st, 2012.

The amount of cash churning through the financial services companies is increasing, but is it translating into higher profits? The answer is yes. Capital One posted a gross quarterly profit margin of 90.49% on September 30th, and Discover posted a gross quarterly profit margin of 85.79% on August 31st. Basic financial services, such as credit and debit cards and payment processing, are paying off.

Selling Financial Services to the Unbanked

The payoff will probably continue as the public seeks an alternative to traditional banks. Around 10 million Americans, or 8.2% of American households, now have no bank account of any kind, according to a survey by the FDIC. That number increased from 1% in the last similar survey by the same agency. The FDIC also reported that around 20.1% of American households are now underbanked. That means they have a bank account, but they use other methods of payment, such as payday loans or money orders. The number of the underbanked grew by around 2%, the FDIC reported.

These numbers represent opportunities for the financial services industry, because all of those people still need to pay bills, cash paychecks, and buy groceries. Yet many of them don't trust banks or associate traditional banks with poor service and high fees. Wal-Mart and American Express's Bluebird card is one obvious attempt to serve such customers. It offers no fee and provides most of the services of a standard checking account, including electronic bill pay. A person can sign up for Bluebird without a credit score.

Capital One's cafes are another attempt to reach this group. They are friendlier than a traditional bank, yet offer fewer services. Instead of tellers, a person who visits the café finds a coffee bar, a sandwich shop, a salad bar, flat screen TV to watch, wireless internet, and beanbags. There will be no safety box or cash services either, which will reduce the cost of operation. Instead, Capitol One employees on site will help visitors open accounts online or with smartphone apps. All of the banking will be electronic.

This strategy can help Capital One from losing customers to eBay's PayPal, Google's (NASDAQ:GOOG) Google Wallet, and American Express's Bluebird, which provide a variety of banking services without a bank account. Capital One's strategy for competing with these services is to leverage the ING Direct Assets it purchased earlier this year. This will enable Capital One to go after middle and upper class customers that want more traditional banking services, but don't necessarily want a bank anymore.

Capital One recognizes that people are moving away from traditional banks. In addition to alternatives such as debit cards, more people are taking advantage of online banking. Many people no longer think of a bank as a building; instead, they view it as a smartphone app or a website.

It's a brave new world of financial services out there, and Capital One is in a good opportunity to take advantage of it. The company has figured out how to turn all of those new financial products into cash. It reported making $9.672 billion in cash from operations on September 30th. There seems to be no reason why Capital One can't continue with that.

The new world of financial services is definitely an opportunity for value investors, and Capital One is one of the best values in it. It generates a lot of cash, and it is constantly looking for opportunities to generate more. More importantly, it looks like there are many such opportunities out there.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.