Capital One: Long-Term Gains Ahead

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About: Capital One Financial Corporation (COF)
by: Zac Thompson
Summary

Capital One is moving away from home equity loans and mortgages which will grant it greater efficiency in the sectors in which it continues operating.

Capital One has made several strategic acquisitions to boost its position as a leading credit card provider and consumer debt service.

Capital One is seeing greater returns from its consumer and commercial banking segments.

Image Source: Capitalone.com

Intro/Investment Thesis

Capital One Financial Corporation (NYSE:COF) is a diversified financial services holding company with many subsidiaries. The company has three primary business segments: Commercial banking, consisting of providing financial services to businesses, consumer banking, geared towards providing banking services towards the general public, and credit cards, which provide small lines of credit to consumers. Capital One operates in a highly competitive industry, competing against other companies like Mastercard (NYSE:MA) and Discover (NYSE:DFS) for the credit card sector, and regional and national banks for banking services. In its most recent quarter, Capital One reported that 75% of its revenue came from its credit card business, 14% from consumer banking, and 11% from commercial banking. Until Capital One increases the proportion of banking services to credit card services, it should primarily be viewed as a credit card company when contemplating an investment. Nonetheless, each of its main business sectors should be treated accordingly to get a full picture of the company's overall financial health, as well as to get an idea as to where the company is heading in 2019.

Capital One enjoys high profit margins from two of its three business cores: credit cards and consumer banking. Its commercial banking revenue lags behind somewhat, but this accounts for its smallest segment. Meanwhile, the company has adopted a corporate strategy that emphasizes its credit card business over the others, and its strategic developments in that arena present a new buying opportunity which should yield impressive returns going forward.

Credit Cards

Capital One's claim to fame is its credit cards, a convenient and easy way to make day-to-day purchases on a line of credit. Though competition in credit card issuance is fierce, Capital One remains one of the nation's top issuers, behind American Express and some of the big banks such as Bank of America and JP Morgan Chase. As its leading business segment and revenue generator, Capital One pays special attention to its credit card sector and its development. In September 2017, the company chose to shift resources away from its banking sector and into its credit card sector with its decision to cease originating new home mortgages and home equity loan products within the consumer banking branch. Capital One shifted its efforts on strategic acquisitions that would boost its credit card capabilities, such as the mass purchase of credit card loans from Synovus and Cabela's.

In its most recent quarter, consumer trends have benefited Capital One, as overall purchases made with its cards are up 10% compared to this time last year, with credit card revenue up 2%, a healthy number for this line of business. Likewise, Capital One has enjoyed a decrease in credit loss, down roughly 11% from this time last year. Together, these statistical trends have granted the company a revenue margin of 16% on its cards.

source: Capital One Q4 earnings presentation

Capital One does cite some risks associated with its largest revenue producer. Credit card spending is subjected to seasonal volatility, as consumer spending fluctuates during the holidays. Furthermore, if payment patterns change, default rates and delinquencies could rise which would hurt their bottom line. Given the state of the domestic economy, though, with unemployment rates low and consumer confidence high, Capital One seems confident that these risks are worth citing for transparency, but will likely not be cause for concern in the immediate future. Instead, the big risks seem to come from the capital markets, as a rise in interest rates or increased costs associated with funding activities may affect operational profit long before the next recession might. Nonetheless, credit cards remain Capital One's anchor and can be relied on to continue producing hefty profits for the company in the coming years.

Banking

Capital One is scaling back its lending in the consumer banking sector, particularly with home loans and mortgages. This is due to a shift in its strategic planning, which involves moving resources out of lower profit sectors and into higher profit ones. As a result, Capital One has stated that its booked loans are down 21% from the same period last year. Even though the company looks to move away from consumer bank lending, it still offers basic consumer banking products and services, and as such, has continued growing its deposits. According to its most recent fiscal quarterly results, consumer deposits have risen 7% year-over-year, which will provide the company with additional capital it can use to fund its other activities.

source: Capital One Q4 earnings presentation

The commercial banking sector is Capital One's weak link, but fortunately is also its smallest component from an operations standpoint. Capital One has increased its lending activity to businesses and other commercial enterprises in an effort to boost its margins here, with loans being up 9% year-over-year, but revenue from the sector is down by roughly the same amount, as are its deposits.

source: Capital One Q4 earnings presentation

Concluding Remarks

Capital One is a solid investment, as its credit card business segment will lead it to profitable times ahead. Through its credit card business and its initiatives that focus on expanding it, Capital One has been able to steadily grow its revenue and margins over the past several years.

source: TD Ameritrade

In the financial sector, Capital One trades well below its peers in terms of P/E and P/B ratios, indicating that the company is currently trading at levels that could be considered to represent great value.

source: TD Ameritrade

As Capital One expands its credit card business in 2019 through more strategic initiatives, it will see its margins expand and its bottom line swell. At current price levels, one cannot ignore this discounted stock, and it pays a nice dividend as well.

Disclosure: I/we 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.