Discover Financial Services (NYSE:DFS), one of the leading American credit card lenders, launched a new zero annual fee card called "It" on January 2, which is an extension of its popular Discover More card. "It" comes with similar features except that with the new card, Discover is being slightly more generous with its rewards program. The company gives its customers a 5% cash back on select categories with both "More" and "It" cards but for all other categories, the latter offers 0.75% more cash back for purchases that fall within a cap of $3,000 per year.
Discover posted its last quarterly results about 20 days ago in which its profits increased by 7.4% from the same quarter last year to $551 million, which translates into $1.07 per share but missed analysts' estimates by 6 cents, which caused its stock to drop by 3.42% on December 20. Total purchases made using the company's cards increased by 6% to $26.5 billion and credit card loans also increased by 6% to $49.6 billion. The company's quarterly revenue (net of interest expenses) increased 10.6% to $1.99 billion for the three months ending November 30, 2012 from last year but its expenses increased by 19.5% in the same period to $800 million and as a result Discover earned less than analysts' estimates.
However, the business is on track toward long-term growth. The good news for investors was that the quarterly dividends have been increased by 40% to $0.14 per share. The company is diversifying its portfolio under the leadership of its Chief David Nelms. Discover is already one of the leading U.S student loan lenders and now it is entering the mortgage market. The business has missed the current earnings estimates due to higher marketing and employee costs, both of which are up 21.4% and 33.3% from the year-ago quarter. Combined, the two form 58.75% of the company's total expenses. Its current expansion strategy will result in higher employee and marketing costs in the future as well, which is going to cause a drop in EPS estimates for the current year.
Meanwhile, earlier this year, Discover Financials announced that it will be partnering with eBay's (NASDAQ:EBAY) PayPal. From 2013, PayPal's customers will be able to purchase goods from 8 million bricks and mortar stores in the U.S. PayPal's customers will receive Discover's debit cards, which will be used to make payments. The merchants will then pay the processing fee to PayPal and PayPal will give the network usage fees to Discover. Essentially, all of PayPal's American customers will now come under the umbrella of Discover's electronic cards. The deal is a win-win for both the companies but Discover looks to gain more out of it.
In the meantime, Discover's bigger rival, Capital One Financial Corp (NYSE:COF) is gearing up for its earnings release due on January 17. In its previous earnings release for its third quarter, the company posted a 44% increase in profits. Unlike Discover, Capital One is expanding through acquisitions, which includes the purchase of HSBC's U.S credit card portfolio and the takeover of the internet bank ING Direct (which will be called Capital One 360 from February). The business has added $30 billion to its credit card loan portfolio through ING's acquisition therefore Capital One will post a considerable increase in revenue and profits for the coming quarters, as opposed to the 90% drop in profits after HSBC's purchase, but the market for commercial and automobile loans remains extremely competitive. The online bank is also opening up brick and mortar banking "cafes" that instead of offering traditional banking services of deposits and withdrawals will be used to introduce the customers to the world of online banking. It already has eight such cafes while in 2013, it will open up six new branches in the Boston area.
The shares of Discover and Capital One are currently trading at $39.53 and $61.23. In the past six months, both of them have risen by 13.30% and 11.83% while in the same period, S&P 500 (SPY) is up by 7%. Their performance in the calendar-year 2012 was even more impressive when the shares of DFS and COF posted an increase of 60.63% and 36.97% respectively while the S&P 500 rose by just 13.46% in the corresponding period.
Discover's current P/E is 8.86 and it offers a better yield and a higher return on equity than Capital One. Stifel Nicolaus and FBR Capital have currently rated it as a "buy" and "market perform." I believe that Discover is all set for growth in 2013 and is a buy at the moment. Despite the increase in marketing and employee expenses, the current quarter's EPS is expected to increase slightly by $0.01 and by $0.02 in the next quarter. Its PayPal partnership will guarantee a continuous stream of revenue for the long term. Both Thompson Reuters and The Wall Street Journal's MarketWatch have set a price target of $45.57 and $45.50, which is at least $5.97 more than the current price.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.