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We have retained our Neutral recommendation on Discover Financial Services (DFS - Analyst Report) based on the company’s fundamental strength, which offsets headwinds such as rising expenses and competitive pressure.

Why Reiterate?

Discover Financial’s card sales volume has been increasing over the past several years due to higher average spending per customer, increase in new customers, impact of increased marketing and broadened merchant acceptance. Moreover, the company continues to launch new products tailored to specific customer needs in order to attract new customers.

This Zacks Rank #2 (Buy) company has implemented several capital bolstering initiatives, including equity and debt offerings, which have helped it achieve a strong capital base. Moreover, the strong cash position and outlook influenced management to increase Discover Financial’s dividend by 43% in Apr 2013.

Moreover, Discover Financial regularly forms alliances to boost card acceptances and expand its network. The company is also working hard to establish a foothold in the international card market and has already forayed into India, China, Ecuador, Russia and Nigeria, among others.

However, Discover Financial incurs considerable expenses in order to compete with other credit card issuers to attract and retain customers, and increase card usage. Moreover, the company’s competitors in the credit card business have substantially larger scales of operation, posing ample risk on the operational front. Not only do the competitors have a relatively stronger global presence and brand names, but they own exclusive contracts with many financial institutions as well, thereby limiting Discover Financial’s business opportunities with such institutions.

Despite these negatives, Discover Financial’s earnings remain strong. The company reported first-quarter 2013 earnings per share (EPS) of $1.33, surpassing the Zacks Consensus Estimate of $1.12 as well as the year-ago quarter’s earnings of $1.21.

Even in the second quarter of 2013, Discover Financial’s EPS is expected to grow 15.42% year over year. The Zacks Consensus Estimate for the company’s second-quarter earnings stands at $1.15.

Other Stock to Consider

Other companies worth considering in the financial sector are Capital One Financial Corp. (COF - Analyst Report) – Zacks Rank #1 (Strong Buy), World Acceptance Corp. (WRLD - Snapshot Report) – Zacks Rank #2 (Buy) and Regional Management Corp. (RM - Snapshot Report) – Zacks Rank #2 (Buy).

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