Credit Card Services Review: 3 Sector Plays

Includes: AXP, COF, DFS
by: Julie Young

The U.S. Financial Sector has been reporting strong gains in 2012. Year-to-date the S&P 500 Financial Sector has gained 15.37 percent. After extensive financial regulation and tightened bank lending standards the sector appears to be strongly recovering from the 2008 credit crisis. Five-year return numbers, however, still continue to show the crisis' affects. On a five-year basis the S&P Financial Sector has a total return of -13.15 percent, dragging down the overall S&P 500 return to 1.21 percent. Additional total return data can be found below in Table 1.

As the sector improves, Credit Card Services has emerged as one sub-industry group showing some standout stock performance. Discover Financial Services (DFS), American Express (AXP), and Capital One Financial Corporation (COF) comprise the majority of the Credit Card Services sub-industry group. This article takes a deeper dive into their publicly reported financial positions and also looks at what has been driving their year-to-date total return performance.

On a year-to-date and one-year basis Discover Financial Services has been leading stock returns in the S&P Financial Sector, gaining 52.88 and 48.11 percent, respectively. Based on its most recently reported earnings the company records a 12-month trailing P/B of 2.18 and P/E of 8.41 with a one-year EPS growth rate of 232.79 percent due to recent buybacks. The company has been providing strong shareholder returns year-to-date driven by direct banking and network transaction volumes but year-over-year income growth has decreased and legal reserve expenses are a factor in their forward-looking operating expense estimates. Based on their underlying position the company appears to be experiencing a reduction in market share which could lead to stock devaluation.

American Express appears to be the leading investment in the S&P Financial Sector's Credit Card Services sub-industry group. The company has posted year-to-date and one-year returns of 23.36 and 19.46 percent, respectively. The company recently reported net income of $1.3 billion for the second quarter of 2012 which resulted in a 1 percent year-over-year increase. Compared to its peers, DFS and COF, the company leads the projected EPS growth category based on one-year and five-year forward-looking estimates at 1.1 and 5.1 percent, respectively. The company has avoided expenses incurred from industry litigation and appears to be capturing a greater portion of market share in the Credit Card Services sub-industry group.

Capital One Financial Corporation rounds out the top-three companies in the sub-industry group by market capitalization, ranking second at $32.90 billion. On a year-to-date and one-year basis the company's stock has returned 36.39 and 25.72 percent, respectively.

Similar to DFS the company has struggled to generate consistent income growth. In its most recent earnings report COF stated a second quarter net income of $93 million compared to $1.4 billion in the previous quarter and $911 million in the second quarter of 2011. Net income levels for the company have been negatively impacted in the short-term by its acquisition of the HSBC U.S. card business and the business integration is expected to greatly affect the company's long-term growth.

Additionally, an industry-wide settlement regarding credit card processing fees was recently announced in July and will affect Capital One Financial. The company will incur losses for settlement payments to retailers in relation to previous credit card processing fees. Furthermore, the company recently entered into an agreement with the OCC and the CFPB which requires them to refund customers for previous sales practice issues. These expenses and the integration of the HSBC business are likely to add downward pressure on the stock price in the near term.

Supporting data on DFS, AXP, and COF can be found in the tables below.

Overall, it appears the Financial Sector is strongly recovering from the height of its losses in 2008. The Credit Card Services sub-industry group provides some interesting investment opportunities and American Express appears to be the Credit Card Services leader as it continues to capture market share and post year-over-year income growth.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.