Is the price of Discover Financial Stock reasonable?

Discover Financial Stock (NYSE: DFS), the credit card giant, has gained 30% year-to-date, from its value of $ 91 at the start of 2020 to around $ 117 now, outperforming the S & P500, which has risen by 24% over the same period. In addition, the company’s net interest income and discount and interchange fees for the first nine months of 2021 improved 3% and 27% year-on-year, respectively.

There were two clear reasons for this: First, the relaxation of travel bans and Covid-19 restrictions have benefited consumer spending levels. Second, favorable financing costs.

But we believe there is more potential to come over the next few months.

Trefis estimates Discover the valuation of Financial at around $ 134 per share – around 14% above the current market price – based on a key opportunity and risk factor.

The opportunity we see is the growth of Discover Financial Revenues over the following quarters. The company generates more than 90% of its total revenues in the direct banking segment. Of which nearly 85% of the share comes from NII. The NII suffered a 2% year-on-year decline in 2020, due to lower outstanding loans and headwinds in interest rates. In addition, non-interest income was down 7% year-on-year due to lower discount and interchange fees. That limited the company’s revenue to $ 11.1 billion in 2020, down 3% year-on-year. That said, the trend has changed in fiscal 2021. The company recently released its third quarter results, beating consensus estimates for both revenue and earnings. It posted total revenue of $ 2.8 billion, up 2% year-on-year, thanks to 6% growth in NII and 26% in discount and interchange fees. Notably, sales were partially offset by – $ 167 million in unrealized gains / (losses) on equity investments. Overall, the NII and the discount and interchange fees both saw some improvement in the first three quarters of fiscal 2021. The cumulative NII for the first nine months improved by 3 % year-on-year, mainly due to favorable financing costs due to lower market rates and lower interest charges. In addition, discount and interchange fees increased 27% year-on-year over the same period, mainly due to higher transaction volumes.

Going forward, we expect the same trend to continue in the last quarter of fiscal 2021. Overall, this will likely allow Discover Financial to

DFS
revenue to reach $ 12.1 billion in fiscal 2021. Our dashboard on Discover Financial Revenues offers more details on the business segments.

Discover Financial’s profitability figures suffered in 2020 due to a large build-up for credit losses and an increase in expenses as a% of revenue. However, the company reduced its provision figure in 2021, due to improved loan repayment capacity of its customers. In total, the adjusted net margin is expected to drop from 10% to around 43% during the year, leading to net profit of $ 5.2 billion. It should translate into EPS of $ 18.01, which when paired with a P / E multiple just below 8x will lead to a valuation of around $ 134.

Finally, how much should the market pay per dollar of Discover Financial profit? Well, to make almost $ 18.01 a year from a bank today, you would have to deposit around $ 1,801 into a savings account, which is roughly 100 times the desired earnings. At the current Discover Financial share price of around $ 117, we’re talking about a P / E multiple just below 7x. And we think a figure closer to 8x is appropriate.

However, credit card issuance and electronic payment solutions are emerging as a risky business today. Growth looks less promising and the short-term outlook is less than rosy. What is behind this?

Discover Financial is heavily dependent on net interest income and consumer spending levels. While the NII has seen some recovery due to falling financing costs, the company has experienced stagnant growth in overdue loan balances. This limited the growth potential of NII in the short term. In addition, levels of consumer spending have improved in recent quarters. However, any sudden increase in the number of Covid cases or any worsening economic conditions can undermine the current trend. In summary, we believe the Discover Financial stock is undervalued.

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