Discover Financial Services (DFS)

During the great recession of 2008-09 credit all but froze completely. The average American (and global) consumer went into panic mode shifting from high spending to extreme saving.

Banks and credit card companies also froze their lending practices as they tried to reconfigure their risk models and remained unsure of just how bad defaults on loans and revolving lines of credit would turn out to be. At the peak of the recession, it was hard to tell what banks and credit card companies would look like or if they would even be around in a year or two.

Since the crisis, consumer credit has been increasing. Revolving credit lines are on the rise and based on overall data, the US consumer is getting just a little bit stronger each week. Debit card transactions remained fairly steady compared to credit card transactions in the downturn and Discover generates income from ATM and debit transactions through its Pulse system.

With a diverse banking, credit and transactional business, Discover might just continue to see upward momentum as consumer strength improves.

Company Description & Developments
Discover Financial Services is a direct banking and payment services company. They operate as both a bank holding company and a financial holding company.

Their “Discover card” which is offered through the Discover Network lends revolving credit to consumers to spend with merchants that accept their service. The credit side also runs the Goldfish credit card business in the UK.

In addition to lending, they also generate fees from their credit card payments network. The PULSE network (PULSE) generates fees through debit and ATM transactions as well as electronic funds transfers.

On March 1st, the company posted strong results for FY2011. DFS increased its market acceptance at more than 380,000 ATMs worldwide in 2011, an 8.6% compared to 2010; it’s already vast network added about 129 direct financial institution participants

The PULSE segment increased total transaction volume by 16% year over year to a record 3.8 billion and grew total dollar volume by 19% annually to $140 billion.

Several analysts including Zacks have raised their profit targets on the stock since the report. Zacks current price target stands at $36 for the financial services company.

Financial Profile
DFS is a large-cap (16.16 billion) company that is trading at about 9 times forward (expectations for next quarter) earnings. They became a Zacks Rank 1 strong buy on February 15th, but has been between and 2 and 1 rating since December 17th, 2011.

They reported a quarterly sales increase of 28% at their last earnings report and has now topped analyst estimates for the last four quarters; beating the mark by 37 cents in the second quarter, 31 cents in the first quarter, and by 22 cents in the fourth quarter of the last fiscal year.

Net income for DFS rose to $649 million ($1.18 per share) vs. $260.6 million (47 cents per share) in the same quarter a year prior, which is an increase of 150% on total sales of roughly 8.6 billion in FY2011. They are expected to earn $3.40 in FY2012 according to the Zacks Consensus Estimate.

Discover reported improvements in several segments and saw Total loans grow 17% from the prior year to a record $57.3 billion. The company purchased an additional $2.4 billion in private student loans in the fourth quarter.

Dividends were increased 67% and last declared a cash quarterly dividend of $0.10 per share of common stock, payable on Jan. 19, 2012. The company also repurchased 9.6 million shares in the fourth quarter for $227 million, bringing the total shares repurchased for the program to 18.0 million or $425 million.

Earnings Estimates
Of the 19 analysts who cover DFS, the consensus is for the company to see a 16% earnings contraction in the current year (FY2012) and roughly flat in FY2013. Many banking models are still factoring in quite a bit of risk. That doesn’t mean shares can’t move higher and remember that DFS is trading at less than 9 times earnings.

In terms of the magnitude of analyst estimate trends, we are seeing all of the consensus estimates higher than they were 90 days ago for the current and next quarter as well as FY2012 and FY2013.

DFS is expected to earn 88 cents when they report on March 21st.

Market Performance & Technicals
Discovery Financial’s stock has come a long way over the last 18 months, more than doubling in value. For the last half of 2011, Discover was in a consolidating wedge formation, which typically leads to a breakout.

That breakout occurred in early January when the stock broke above its major moving averages and rallied $7 or 30% in about 2 months time. DFS is currently above both the 50 and 200 day averages of $27.52 and $25.09 respectively.

DFS has exceeded the S&P 500’s performance in the past year by almost 36% and outpaced it by over 14% in the past 3 months during its recent rally. The stock remains in a bullish trend and has maintained its momentum in the past month, leading the index by about 6%.

Jared A Levy is the Momentum Stock Strategist for Zacks.com. He is also the Editor in charge of the market-beating Zacks Whisper Trader Service.