Discover Financial Services

Discover Financial Services (DFS)

Back in early March, DFS was featured as a momentum stock due to its stellar performance and relatively inexpensive valuation. An improving economic climate here in the states and increasing transactional volume globally were primary motivators. Recent developments indicate that those trends may be fading or at least not as apparent as they were in March.

In early May, Five Star Equities noted that credit card spending fell by $5 billion in the first two months of 2012, compared to the year prior. What’s more is that consumer spending, which makes up 70% of U.S. GDP has been rising at a faster pace as of late, but Americans are charging less on their credit cards (according to Five Star).

These mixed trends haven’t fazed Discover Financial Services; its stock continues to climb. Discover stock has increased over 10% since last mention. Is there still room for DFS to rise?

Consumer Trends Shaky
Discover’s own U.S. Spending Monitor, which is an index that has been tracking daily economic confidence and spending habits of nearly 8,200 consumers for over 5 years, climbed 0.2 points to 96.7, its highest level since October 2007. That same index also showed consumer confidence unchanged in April, but generally flat to positive.

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. What is interesting is that despite increasing concerns about the U.S. economy and rising gas prices, more consumers reported positive attitudes about their personal finances in April.

The report noted that 27 percent of respondents said their personal finances are getting better, an increase of 2 percentage points over March. Feelings that personal finances are getting worse remained flat.

Credit/Debit Trends
Visa, which is one of Discovers competitors reported a 30 percent year over year profit in Q1. They cited strength in credit card usage and here in the United States and overseas. Visa said American consumers charged 12% more on their credit cards compared to Q42011. Debit card use grew by 4 percent, the slowest growth in a year. This may be due to the reduction or elimination of debit card rewards programs since October, upon the implementation of the “Durbin Rule” portion of Dodd-Frank, which limits the fees banks can charge stores for card transactions.

Just yesterday, the Federal Reserve reported that U.S. consumers increased their debt in March by a seasonally adjusted $21.3 billion. This marks the seventh straight monthly gain in consumer borrowing. The March increase was the largest since November 2001, and double the roughly $10 billion gain expected by many economists.

Company Description
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.

DFS is particularly attractive due to its low P/E ratio of 8.45. Being that Discover operates a diverse banking, credit and transactional business, they may continue to see upward momentum if the consumer situation continues to improve.

Financial Profile & Earnings Estimates
DFS is a large-cap (17.78 billion) company that jumped back up to a Zacks Rank 1 strong buy on April 13th, it has been rated between 2 and 1 since December 17th, 2011.

They reported a quarterly sales decrease of 22% at their last earnings report, but managed to register a 24% EPS gain in the same period. Their bottom line has topped analyst estimates for the last five quarters. They have managed to exceed the Zacks Consensus EPS Estimate by an average of 28.43% over the past year.

DFS is expected to earn $3.97 in FY2012 according to the Zacks Consensus Estimate and it currently yielding a 1.2% dividend.

Of the 19 analysts who cover DFS, the consensus is for the company to see a 2.26% earnings contraction in the current year (FY2012) and another negative 2.32% in FY2013. Although that seems dismal, it’s quite an improvement over estimates from last quarter. Many banking models are still factoring in quite a bit of risk.

In terms of the magnitude of analyst estimate trends, we are seeing all of the consensus estimates higher than they were 30 days ago for the current and next quarter as well as FY2012 and FY2013.

DFS is expected to earn 93 cents when they report on June 21st.

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