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Discover Financial Beats on Q4 Earnings

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Discover Financial Services (DFS - Free Report) reported fourth-quarter 2013 earnings per share (EPS) of $1.23, which exceeded the Zacks Consensus Estimate of $1.17 per share. EPS also improved 16% from the year-ago quarter’s number of $1.06.

The improvement in Discover Financial’s EPS is largely attributable to growth in loans and share repurchases during the quarter. Net income allocated to common shareholders increased to $588 million from $530 million in the year-ago quarter.

Discover Financial’s total revenue, net of interest expense, increased 6% year over year to $2.1 billion, beating the Zacks Consensus Estimate of $1.74 billion. The enhancement came on the back of loan growth and higher net interest margin in the Direct Banking segment as well as growth in card sales volume. Net interest income also improved 10% to $1.57 billion reflecting loan growth, higher loan yield and a decline in interest expense.

Moreover, total other income for Discover Financial decreased 4.8% from the prior-year quarter to $560 million. On the other hand, total other expenses increased 4.4% to $838 million.

Segment Update

Direct Banking Segment

Discover Financial’s Direct Banking segment reported pre-tax income of $911 million, reflecting a 12% rise from the year-ago quarter. Revenues, net of interest expense, for the segment increased 6% to $115 million. The rise was supported by higher loans as well as an increase in net interest margin that was fueled by lower funding costs and an improvement in loan yield.

Discover card sales volume grew 3% year over year to $29.5 billion. Total loans improved 5% to $65.8 billion, boosted by a 4% increase in credit card loans, a 5% increase in private student loans and a 27% surge in personal loans.

Other income decreased 5% year over year, primarily due to a decline in direct mortgage related income. Meanwhile, expenses increased 4% to $781 million.

Discover Financial’s credit card net charge-off rate declined to 2.09% from 2.31% in the year-ago quarter. The dip was primarily attributable to growth in personal loans. Similarly, the over-30 days delinquency rate improved to 1.72% from 1.79%.

In addition, provisions for losses decreased $18 million year over year to $352 million, reflecting a decline in reserve additions and charge-offs. Reserve build during the quarter was $50 million, lower than $57 million in the year-ago quarter.

Payment Services Segment

Pre-tax income in Discover Financial’s Payment Services segment declined 18.7% year over year to $26 million. Revenues in the segment in fourth-quarter 2013 decreased $2 million to $85 million, reflecting a decline in transaction processing revenues from PULSE.

Payment Services dollar volume declined 1% from the year-ago quarter to $49.8 billion. Meanwhile, the transaction dollar volume from PULSE was in line with the year-ago quarter.

Full Year Highlights

For full year 2013, Discover Financial recorded operating earnings per share of $4.96, up 10% from $4.50 in 2012. Full year earnings also surpassed the Zacks Consensus Estimate of $4.91.

Revenues net of interest expense increased 7% year over year to $8.2 billion.

Total other income improved 2% year-over-year to $2.3 billion, while total other expenses increased 4% to $3.2 billion.

Financial Position

Discover Financial had total assets worth $79.3 billion as of Dec 31, 2013, increasing from $73.5 billion as of Dec 31, 2012. Total equity stood at $10.8 billion at the end of Dec 2013, up from $9.9 billion at the end of Dec 2012.

Book value per share was $22.89 at the end of the fourth quarter of 2013, compared with $19.83 as of Dec 31, 2012.

Return on equity was 34% at the end of 2013, compared to 26% at year-end 2012. Tier 1 common capital ratio at the end of 2013 was 14.3%, compared to 13.6% at the end of 2012.

Share Repurchase Update

During the reported quarter, Discover Financial repurchased 7 million shares for $345 million, leading to a sequential decline of 1% in shares outstanding.

Dividend Update

On Oct 16, 2013, the board of Discover Financial declared a quarterly cash dividend of 20 cents per share, payable on Feb 20, 2014 to shareholders of record as of Feb 6, 2014.

Our Take

Discover Financial successfully met the earnings and revenue expectation. Loan growth and net interest margin expansion was impressive in the quarter. These coupled with share repurchases aided the outperformance in the quarter. Additionally, lower attritions and charge-offs helped Discover Financial to keep its earnings streak alive.

The Direct Banking segment performed impressively during the quarter, with growth in card sales that was fueled by higher wallet share with the prevailing customers as well as by receiving new accounts. Going forward, the launch of products like Cashback, home equity installment loans and the initiation of the FICO scores on the “Discover it” cards is expected to help the segment generate more revenues, making way for long-term growth.

However, a highly competitive environment marred the Payments Services segment’s performance. Although headwinds like a challenging economic environment in Europe and the active debit card environment might continue to weigh on the financials of the segment in the near term, the long-term prospects look promising.

Zacks Rank

Currently, Discover Financial caries a Zacks Rank #3 (Hold). Some better-ranked stocks in the financial services space include Fidelity National Information Services, Inc. (FIS - Free Report) , Heartland Payment Systems, Inc. and MasterCard Incorporated (MA - Free Report) . While Fidelity and Heartland carry a Zacks rank #1 (Strong Buy), MasterCard carries a Zacks Rank #2 (Buy).

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