Basic Business / Product Analysis
Discover Financial Services (DFS) provides banking and payment services by offering customers credit card loans, private student loans, personal loans, and home equity loans, among other products. As of year-end 2018, the company had $90.5 billion in loan receivables and $44.7 billion in deposits issued through direct-to-consumer channels and affinity relationships. DFS operates Discover Network, the PULSE network (“PULSE”) and Diners Club International (“Diners Club”), which are core drivers of the payments business. The Discover Network processes transactions for Discover-branded credit and debit cards, providing payment transaction processing and settlement services. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on the PULSE network with access to ATMs. Diners Club is a global payments network of licensees.
Valuation
While the comps analysis from the networks, such as Visa and MasterCard, gives Discover an upside to its multiple, there are a number of banking-driven factors that push the comparative multiple downward, particularly when one takes into account potential slowing down in loan and spending, as well as the prospective worsening of credit performance in next 1-3 years. Consequently, we believe that a fair P/E multiple for Discover on 2020 earnings is 10.2x. When we apply it to our 2020 EPS estimate of $10.01, we get the target price of $102.
What to Expect from 4Q Print
- See 6% Y/Y Growth in Payment Services, driven by solid network volumes. Our channel checks from Nilson data, as well as the latest Visa, MasterCard, and American Express earnings reports, indicate that payments volume remains solid, particularly in developed markets, such as the United States and Western Europe. We expect the credit side of the business to grow in low-mid single digits in the US, with upper single digit growth, closer to 10-10.5%, in the United States.
