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Will Higher Expenses Hurt Capital One's (COF) Q3 Earnings?

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Capital One Financial Corporation (COF - Free Report) is scheduled to report third-quarter 2016 results on Oct 25, after the market closes.

Last quarter, higher expenses and provisions dragged Capital One below the Zacks Consensus Estimate. However, improved revenue growth and stable expenses were the tailwinds.

Further, for the third quarter, the stock witness four downward revisions in earnings estimates (versus three upward revisions) over the last 30 days. Notably, the Zacks Consensus Estimate of $1.94 has remained stable over the last 7 days.

Further, Capital One does not have a decent earnings surprise history, as evident from the chart below:

CAPITAL ONE FIN Price and EPS Surprise

 

CAPITAL ONE FIN Price and EPS Surprise | CAPITAL ONE FIN Quote

Earnings Whispers

Our quantitative model does not predict an earnings beat. Here is what our model indicates:

Chances of Capital One beating the Zacks Consensus Estimate in the third quarter are quite low. This is because a stock needs to have both a positive Earnings ESP and a Zacks Rank #3 (Hold) or better for this to happen.

Zacks ESP: The Earnings ESP for Capital One is -1.03%. This is because the Most Accurate estimate of $1.92 is below the Zacks Consensus Estimate of $1.94.

Zacks Rank: Capital One’s Zacks Rank #3 increases the predictive power of the ESP. However, we need to have a positive ESP to be sure of an earnings beat.

Also, the Zacks Consensus Estimate for the third quarter indicates year-over-year decline of about 2.4%.

Factors to Influence Q3 Results

Like the prior quarter, will higher expenses and credit cost continue to weigh on Capital One’s profitability? Let’s dig into the factors that are likely to impact Q3 results.

 
Expenses to Remain Elevated: Management has been optimizing branches, hence it expects to incur $160 million as branch optimization costs for 2016. As only $45 million of this cost was incurred in the first half of 2016, the balance amount will be incurred during the remainder of the year. So, part of the remaining branch optimization costs should lead to a rise in expenses in the quarter.

In addition, Capital One expects one-time reward expense during the quarter. This one-time reward costs is due to some system enhancements that will move the reward liability cut-off to the last day of the quarter. Currently, it was measured on a slight lag after the quarter ended.

Further, the company expects the net impact of FDIC surcharges and premium changes to raise the quarterly operating costs by nearly $20 million. Also, operating expenses should go up due to an increase in marketing expenses and continued investments in franchise.

Credit Costs Likely to Rise: Provision for credit losses are likely to rise as Capital One’s credit quality will remain under strain, given the consistent increase in card and auto loans. Further, taxi medallion and energy portfolio are expected to witness degradation.

Improvement in Revenue: Capital One’s top line should benefit from growth in auto, cards and commercial loans. Further, the acquisition of GE Capital’s healthcare finance operation will support revenues, while continued mortgage run-off should put pressure on top line to some extent.

Also, management projects net interchange fees to decline $45–$55 million during the quarter, owing to a one-time rewards expense. Further, custom deals negotiated by large merchants will put pressure on interchange income.

Stocks That Warrant a Look

Here are a few finance stocks you may want to consider as our model shows that these have the right combination of elements to post an earnings beat this quarter:

State Street Corporation (STT - Free Report) is scheduled to report results on Oct 26. The company has an Earnings ESP of +0.80% and carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Raymond James Financial, Inc. (RJF - Free Report) has an Earnings ESP of +2.04% and carries a Zacks Rank #2. The company is slated to release results on Oct 26.

Lazard Ltd. (LAZ - Free Report) , another Zacks Rank #2 stock, has an Earnings ESP of +3.90%. It is scheduled to report results on Oct 27.

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