Economic Recovery Holds Bright Future For Discover Financial Services

| About: Discover Financial (DFS)

By Troy Kuhn

The consumer lending industry was one of the worst-hit industries by the 2008 recession, where industry players were involved in a fight to survive. Now, those hard days are gone and this industry in particular is back on track as the economy pulls itself out of the crisis. Bidness Etc takes a look at the year-to-date performance of Discover Financial Services (NYSE:DFS) and its competitors in the consumer credit industry, with a focus on what the future holds for them.

Discover Financial Services is a direct banking and financial services company. Through its subsidiaries, the company caters to a wide range of credit requirements, including credit cards, student loans, personal loans, and home financing. The company, with its wide portfolio, serves various customer segments and operates in two segments: Direct Banking and Payment Services.

The company has been performing well in terms of the growth in revenues, which grew 5.53% in 2013. However, the growth of its larger competitors is even stronger, with Visa Inc. (NYSE:V) growing at 13.02% and MasterCard (NYSE:MA) at 12.92%. But the performance of American Express Co. (NYSE:AXP) is the worst, with revenue growth of 3.41%. Revenue growth in the industry is largely due to the increase in consumer spending brought about by the blurring effects of recession on consumers and their wallets.

Earnings growth for the industry as a whole is also pleasing. The growth rate for DSF is 11.21% YoY, with rates for AMX, Visa, and MasterCard hovering at 25.45%, 142.6%, and 16.8%, respectively. This growth in earnings has come about because these institutions have experienced lower rates of credit losses, hence reducing the provision for defaults. As more people become employed, their ability to spend rises, and they are less prone to default. The growth rate for profits before provisions further substantiates the fact that the bottom line of these companies is improving due to falling credit losses and delinquencies. The YoY growth in profit before provisions for DFS is 3.39%, 12.29% for AMX, 16.24% for Visa, and 15.98% for MasterCard.

Compared with the growth in earnings, these figures in general are small, hinting towards the contribution of low default rates in curtailing credit companies’ losses and provisional expenses. As of the end of 2013, the net charge-off rate for the US stood at 2.04%, falling to 2.02% in 1QFY14, the lowest since 2006.

When compared on the basis of their 12-month blended forward price/book multiples, DSF is the only stock trading at a discount to the industry average. Its multiple of 2.45x is at a discount of 25.8% over the industry average of 3.27. AMX, Visa, and MasterCard stock is trading at a premium of 39.1%, 30%, and a staggering 248%, respectively, to the market. This means that DFS is relatively undervalued by a huge margin, and holds a massive upside potential compared to its peers.

The future for credit companies in general, and DSF in particular, is promising. With unemployment having dropped to 6.1% in June this year, growth in retail sales of 0.2% MoM in the same month, and the interest rates expected to increase, revenues and profitability of credit issuing firms are on a road to further growth.

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