Decline in Consumer Spending Could Result in 10% Downside for Discovery

| About: Discover Financial (DFS)

Discover Financial Services (NYSE:DFS) is a leading credit card issuer in the United States and an electronic payment services company. The firm offers credit cards, personal and student loans, and deposit products. It competes with other financial firms like Capital One (NYSE:COF), American Express (NYSE:AXP), Visa (NYSE:V) and MasterCard (NYSE:MA).

Discover recently conducted a Holiday Shopping Survey, which examines holiday spending intentions and trends for the upcoming holiday season. Of respondents, 38% are planning to spend less in this holiday season showing an uptick in confidence and a striking 62% of the respondents indicated that they will use cash to pay for most of their holiday purchases this season while 23% indicated that they will use credit for holiday spending [1].

Any decline in use of credit cards in this holiday season can have an impact on Discover whose credit card division makes up 18% of the $17 Trefis price estimate for Discover, which is around 8% below the market price.

Discover’s Sales Volume Trend to Rise

The total amount of purchases made on Discover credit cards declined in 2009 due to the weak economic environment but we estimate that Discover’s sales on credit cards will show an increasing trend moving forward and will reach almost $116 billion by 2013 from around $100 billion in 2010. We are optimistic on our estimate largely because of the shift away from paper based transactions which will drive sales on credit cards and debit cards. In 2009, there were still 8.9 trillion transactions in the US that were paper based which we expect to decline gradually.

However, as consumers appear to be very cautious in their holiday spending this year and they plan to use cash rather than taking on more credit card debt, the increase in Discover’s sales volume may not be up to over expectations if this conservative trend in consumer spending is witnessed over the Trefis forecast period.

There could be 2-3% downside to our estimate of Discover’s stock price if its sales volume remained around current levels in the coming years.

Securitized Loan Amount Will Also Be Impacted

A decrease in sales volume will have an indirect impact on Discover’s securitized loan amounts. A part of the total credit card loans that Discover provide to its customers is transferred to other financial firms or investors at a prefixed rate of return. This process is known as securitization. Income is earned on securitized loans because of excess spread on loan amount.

A stagnant sales volume would lead to a stagnation in average securitized loans at the current level of about $25 billion instead of our forecast of $27 billion by 2013. This would result in an additional 7-8% decline in our price estimate for Discover.

In summary, if the decline in consumer spending is short lived, the impact on Discover’s stock price will be minimal — but a prolonged decline in spending could have an almost 10% negative impact on Discover’s stock price.


  1. Discover 2010 Holiday Spending Survey, Discover Financial

Disclosure: No position