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Diving Into Discover Financial Services

Mar. 06, 2020 2:17 PM ETDiscover Financial Services (DFS)19 Comments


  • Discover Financial Services is down approximately 25% since the release of its 4Q19 and FY19 earnings, that featured a sharp uptick in the expense line for 2020.
  • A focus on building brand awareness and upgrading technology were cited for the disappointing results.
  • An upward revision to loan loss provisions caused by modeling tweaks spurred by a new accounting rule effective January 1, 2020 did not help matters.
  • The stock like almost every equity has been hit hard by fears of the coronavirus outbreak in recent weeks.
  • Significant insider buying after the selloff merited further inquiry. A full investment analysis follows in the paragraphs below.
  • I do much more than just articles at The Insiders Forum: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

You know your children are growing up when they stop asking you where they came from and refuse to tell you where they're going."― P. J. O'Rourke

In today's 'deep dive' we take a look at a well-known financial name. The concern saw some significant recent insider buying in late January and is down approximately 25% from recent highs.

Company Overview

Discover Financial Services (NYSE:DFS) is a Riverwoods, Illinois direct (branchless) banking and payment services concern that offers its customers credit card loans, private student loans, and deposit products. In addition to its namesake credit card, the company also operates Diners Club International and the PULSE network of ATM cards. The Discover Card was first introduced by Sears in 1985 and was the first service to offer cash rewards for purchases. The company - after several corporate metamorphoses - was eventually spun out of Morgan Stanley (MS) in 2007. Its stock currently trades in the mid-70s, equating to a market cap near ~$23.5 billion.

The financial services provider has two reporting segments: Direct Banking, which generates the vast majority of its top line; and Payment Services. Direct Banking includes Discover-branded credit cards issued through its Discover Network/Bank, private student loans - it is the second largest generator of private student loans - personal loans, home equity loans, as well as other consumer lending and deposit products. Most of the top line is generated from interest earned on its $95.9 billion loan portfolio. Credit card discounting and interchange - paid between banks for the acceptance of card-based transactions - protection products and loan fees comprise the other revenue sources in this division. Payment Services principally includes PULSE ATM transaction fees and royalties from Diners Club card licensees.

Discover and the entire consumer financial services industry have been the beneficiaries of a

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This article was written by

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We are a team of analysts led by Bret Jensen, Chief Investment Strategist at Simplified Asset Management.

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Analyst’s Disclosure: I am/we are long DFS. 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.

I have a small position in DFS via recently initiated buy-write aka covered call orders

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (19)

D.S. Leach & C.E. Leach profile picture
@Bret Jensen,

I used Buy-Write strategies in the past but would question using one in this particular environment. There is, I believe, a significant probability that the market may rebound quickly if and when the corona virus infection rate begins to drop off in the US. With DFS's current price, you will likely lose a significant piece of the recovery from current lows via an exercised call. It would be difficult to stay in front of a call being exercised using a roll up/out approach.

That said, I already own DFS and it is on my watchlist for accumulation. I'm probably going to hold on for the full recovery and, at this yield, the dividend payments.

Bret Jensen profile picture
Happy to take less on the upside to protect on downside here....
pone profile picture
On the surface this looks interesting, but a quick review is showing that something is going on with debt that needs to be examined in detail and explained. If I look at Mastercard and Visa, both have remarkable returns on assets of 22% and 13% respectively. DFS is only 2.5% ROA. Now DFS puts up a good return on equity over 25%, so that disparity tells me they must be highly geared and they are juicing debt to produce returns.

How is DFS using debt to produce its ROE? I think the fact that DFS falls like a knife - where Mastercard and Visa have less severe declines - suggests the market perceives a much larger risk to DFS based on that debt and how it is being used.

I would want to see that issue become the entire focus of another article. Understanding that leverage is the key to understanding the risks and opportunities here.
Dividend Ambassador profile picture
@Bret Jensen Bret, I found this article very useful as I was looking at DFS as a candidate for buying in face of the market swoon. Could you comment on where you see things now re:DFS stock now that we are deeper into the COVID crisis and the price of the stock has dropped much lower than when you published this article. Also, how do you assess DFS vs the stocks of other financial on slightly lower sales.
@Bret Jensen commentary to the above question would be appreciated. I am watching this trade now at $34... Wondering if this thing can go even further. What are you doing at these prices?
Bret Jensen profile picture
Keeping my buy-writes in place as they have plenty of duration. Have another couple buy-write orders in using the Jan $35s looking for net debit of $26 today. To put in perspective, the 1918 Spanish Flu killed 500,000 Americans and 50M worldwide. Knocked 5% off our GDP (which was already going to be hit as WWI winded down) and caused the market to fall 40% peak to through. 470,000 people die to AIDS related diseases in Sub-Saharan Africa every year compared to the UN. Does anyone think Covid-19 is going to have nearly the impact?
17 Mar. 2020
The economy carried on running during those times. If this stalls and fiscal policy doesn’t support those out of work (as opposed to payroll tax cut), DFS book is in trouble.

That being said I’m looking to enter via short puts. Let’s see the dust settle. I don’t mind letting it actually climb first seeing recovery and missing the first 15-20% up.
Great write up. Thanks for the commentary.
I wonder when DFS is going to pickup a trading platform to offer to their customer base.
The Insiders Forum profile picture
Interesting speculation. Any names that come to mind?
Its hard to say. I havent really looked into it. I know M1 and DFS are both headquartered in Chicago. Other than that possibility, who knows.

I was just sitting here looking at the services that ALLY offers compared to DFS and thinking of possibilities.

It seems like a brokerage would be the next logical step to help increase DFS's customer base.
I'll pass on DFS for now, but thanks for reminding me how funny P.J. O' Rourke can be.
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