At $ 87, Discover Financial Stock is still undervalued

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[Updated 02/04/2021] Discover the updated financial assessment

Despite a gain of over 200% from the lows of March 23 of last year, we believe Discover Financial Stock (NYSE: DFS) has further upside potential. Trefis estimates Discover the valuation of Financial at about $ 95 per share – about 10% above the current market price. Discover Financial is a leading credit card issuer in the United States and an electronic payment services company. It outperformed consensus estimates in the recently released fourth quarter results. DFS reported revenue of $ 2.8 billion, down 4% from the previous year. This could be attributed to a 2% year-over-year decline in net interest income due to a decline in average receivables and an unfavorable net impact of falling market rates, followed by a decline of 14 % of non-interest income. However, it still managed to increase its EPS by 15% year-on-year, thanks to lower provisions for year-on-year credit losses.

The coronavirus outbreak and the global economic crisis negatively impacted Discover Financial’s revenue in 2020 as people were more focused on the essentials than on discretionary and leisure spending. Declining levels of consumer spending led to a decrease in credit card loans and a decrease in the volume of card purchases – the credit card business (76% revenue share in 2020) suffered a decline of 4% year-on-year during the year. In addition, its net interest margin decreased due to the fall in interest rates. In total, this resulted in a 4% year-on-year decline in revenue for the year 2020, limiting it to $ 11.1 billion. That said, consumer spending levels have improved over the past quarter and we expect the trend to continue over the next few months. It is likely to benefit the turnover of the company, allowing Discover Financial’s income earn $ 11.5 billion in fiscal 2021.

Discover Financial announced a 62% year-over-year decline in its adjusted net income for 2020, due to higher operating costs and a significant increase in its provisions for credit losses. Due to the Covid-19 crisis, its clients’ loan repayment capacity has deteriorated, increasing the risk of default. DFS increased its provisions from $ 3.23 billion to $ 5.13 billion in 2020 to address this risk. This reduced EPS from $ 9.09 in 2019 to $ 3.60 in 2020. However, as the economy normalizes, its customers’ loan repayment capacity is expected to improve, leading to a favorable decrease in loans. provisions for credit losses. Additionally, it is likely to begin its share buyback program in 2021. This will likely allow EPS’s figure to reach $ 8.98 in fiscal 2021. Overall, EPS of 8 $ 98 coupled with a P / E multiple just below 11x will lead to a valuation of around $ 95.

[Updated 08/21/2020] Despite 90% jump, find financial stocks can still grow

Discover Financial Stock (NYSE: DFS) lost nearly 68% – from $ 84 at the end of 2019 to around $ 27 at the end of March – then has climbed almost 90% to around $ 51 now. Despite the recent rally, the stock remains 40% below the level observed at the start of the year.

There were 2 reasons for this: The Covid-19 epidemic and the economic downturn have brought down market expectations for 2020 and consumer demand in the short term. As the company is heavily reliant on the credit card segment and other lending business, this could lead to significant losses due to an expected increase in default rates. The Fed’s multibillion-dollar stimulus provided a floor, and the rally in equities owes a lot to it.

But that’s not the end of the story for Discover Financial stocks

Trefis estimates Discover the valuation of Financial at around $ 59 per share – around 15% above the current market price – based on an upcoming trigger explained below and a risk factor.

The trigger is an improved trajectory for Discover Financial’s income over the second half of the year. We expect the company to report 2020 revenue of $ 11.1 billion, about 4% lower than the 2019 figure. Our forecast stems from our belief that the economy should open up. in the third trimester. Consumer spending in the United States rose 8.5% month-on-month in May, then 5.6% mom in June (Data for July are not yet available). If the ten the months to come. However, net income for the year is expected to fall to $ 1.1 billion, down 62% year-on-year, mainly due to a higher allowance for credit losses, reducing EPS to $ 3.63. for fiscal year 2020.

After that, Discover Financial’s revenue is expected to improve to $ 11.4 billion in fiscal 2021, primarily driven by growth in outstanding credit card loans and higher transaction volume. Additionally, the net profit margin is expected to improve year over year due to lower provisions for credit losses, leading to EPS of $ 5.94 for fiscal 2021.

Finally, how much should the market pay per dollar of Discover Financial profit? Well, to make almost $ 5.94 a year from a bank today, you would have to deposit around $ 650 into a savings account, which is around 110 times the desired earnings. At the current Discover Financial share price of around $ 51, we’re talking about a P / E multiple just below 9x. And we think a figure closer to 10x will be appropriate.

That said, consumer credit is a risky business right now. Growth looks less promising and the short-term outlook is less than optimistic. What is behind this?

Discover Financial has a large portfolio of consumer loans – approximately $ 91 billion in fiscal 2019, of which nearly $ 73 billion is credit card loans. The economic downturn is likely to damage the financial health of many customers, exposing the company to potential defaults. In anticipation of this, Discover Financial increased its loan loss provisions to approximately $ 3.9 billion by the second quarter of 2020, approximately 2.4 times over the previous year, resulting in a significant increase in the total amount of expenditure for the year. If the economic situation continues to deteriorate, this figure could increase further in the coming months.

The same trend is visible through Discover Financial’s peer – American Express. Its revenue is expected to suffer in fiscal 2020 due to lower consumer spending and its net income margin is expected to decline due to increased provisions for credit losses in anticipation of defaults. Additionally, American Express stock is currently priced above $ 97, but is expected to achieve EPS of around $ 6.66 in fiscal 2021.

What if you were looking for a more balanced portfolio instead? here is a high quality wallet to beat the market, with a return of over 100% since 2016, compared to 55% for the S&P 500. Comprised of companies showing strong revenue growth, healthy earnings, plenty of liquidity and low risk, it has outperformed the market in its together, year after year, consistently.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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