Buy Capital One On A Dip

| About: Capital One (COF)

Capital One Financial's (NYSE:COF) third-quarter earnings remained noisy in the wake of the company's acquisitions this year, which included the ING Direct purchase, and the purchase of HSBC's domestic card business closing in mid-2012, according to Fitch Ratings. Fitch expects COF's earnings power to be stronger due to lower funding costs and improved loan yields.

COF's loan growth was relatively flat from the sequential quarter as continued growth in auto loans and some modest growth in commercial and commercial real estate loans, was offset by a continued planned run-off of mortgage loans that COF inherited with the ING Direct acquisition as well as the run-off of some card loans acquired from HSBC.

On balance, COF's credit quality remains reasonably good. However, both overall net charge offs (NYSE:NCO) and 30 day plus delinquencies increased in COF's domestic card portfolio and in its auto portfolio.

COF's Tier 1 common ratio improved to 10.7% in 3Q'12, up from 9.9% in 2Q'12. In 3Q'12, COF disclosed that its Tier 1 common ratio under proposed Basel 3 capital standards would be in the high 7% range, which is on the lower side compared to some peer institutions. However, given COF's strong capital generation Fitch would expect the company to be above their assumed Basel 3 target of 8% in the next year.

COF's quarterly profit rose 44 percent after two big acquisitions, but the lender said increasing competition for automobile and commercial loans may curb future growth. Auto loans, and commercial and industrial lending have helped Capital One offset lackluster demand, but as more lenders chase the same customers, underwriting standards have fallen. New auto loans fell 9 percent from the second quarter.

Net income for the third quarter rose to $1.17 billion from $813 million a year earlier. Revenue rose 40 percent to $5.78 billion. Capital One may return more capital to investors next year if regulators agree. During the second quarter profit fell 90 percent on higher credit loss reserves related to the HSBC card purchase.

The stock is up 35 percent since the start of year. Net interest income rose 42 percent while non-interest income more than doubled.


On a short-term multiplier valuation model basis, Captial One is overvalued. On an absolute basis Capital One is undervalued. The price-earnings ratio is 9.60 and the price-sales ratio is 2.06. The firm is trading at 89 percent of book value.


For investors, corporate America's top-line figures are of particular concern. The beat rate for revenue forecasts is just 41.4 percent, compared to a long-term average of 62 percent, according to Thomson Reuters data.

I have been seeing top-line weakness for some time now. With the release of third quarter results, it seems investors are starting to pay more attention to the slowdown in sales growth.


Capital One has emerged as one of the nation's largest lenders. The firm's financial performance is on an upward trajectory. Liquid ratios are solid and financial performance is good. That said, the firm may be a bit overvalued on a short-term basis. Long equity investors should reduce exposure. I will increase exposure on a decline in short-term multiplier model valuations.

Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.

Disclosure: I am short SPY. 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.

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