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We have retained our Neutral recommendation on Discover Financial Services (DFS - Analyst Report). The recommendation is based on its rising expenses and high competitive pressure, which are expected to weigh on the positives. This direct banking and payment services company currently carries a Zacks Rank #3 (Hold).

Why Reiterate?

Discover Financial incurs considerable expenses in order to compete with other credit card issuers to attract and retain customers and increase card usage. The company’s profits are largely tapered due to the company’s higher-than-expected advertising and marketing expenditures. Information processing and communications expenses, professional fees, premises and equipment and other expenses also increased in 2012, thereby substantially increasing total non-interest expenses.

Moreover, Discover Financial’s competitors in the credit card business have substantially larger scales of operation, posing ample risk on the operational front. Companies in the competitive card business have to offer various incentives and rewards in order to attract customers.

Discover Financial’s rivals have more financial resources than the company due to larger operating scale, which enables them to offer better incentives. Thus, Discover Financial is relatively at a competitive disadvantage, which tends to slow down its growth in the global market.

Nevertheless, counting on the positives, Discover Financial has grown to become one of the largest card issuers in the U.S. and a leading innovator in the credit card industry. Credit card sales volume reached the milestone of $100 billion in 2011 and increased further in 2012.

The company regularly forms alliances to boost card acceptances and expand its network. Discover Financial also continues to explore healthy opportunities for inorganic and is working hard to establish a foothold in the international card market.

Discover Financial reported fourth-quarter 2012 operating earnings per share of $1.07, lagging the Zacks Consensus Estimate of $1.13. However, earnings surpassed the year-ago quarter’s earnings of 95 cents per share.

Other Stock to Consider

Although we have a cautious stance on Discover Financial, other stocks in the financial sector such as Visa Inc. (V - Analyst Report), Fidelity National Information Services, Inc. (FIS - Analyst Report) and Fiserv, Inc. (FISV - Analyst Report), which carry a Zacks Rank #2 (Buy), are worth considering.

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