Discover Financial Earnings Preview: Improving Spending Trends To Boost Results

Discover Financial (NYSE:DFS) is expected to report earnings for the third quarter of 2013 on Monday, October 21. ^[1] The company, best known for its credit cards, is riding a wave of improved consumer spending. Discover maintained a 5% growth rate in aggregate sales transaction volume for the first half of 2013, while total loans increased by 6% over the prior year’s figure. Credit cards account for  80% of Discover’s revenues and gross profits, with 65% of the company’s  revenue coming from interest earned on credit loans and another 15% from discount and interchange fees.

Our $49 price estimate for Discover Financial is in line with the current market price.

See our complete analysis of Discover Financial here

Will The Good Times Continue?

The U.S. Commerce Department reported a 0.3% increase in consumer purchases in August, the fourth consecutive increase in monthly consumer spending. ^[2] This increase was influenced by a 0.4% increase in wages ^[3] as the unemployment rate in the country dropped to a four-year low of 7.3%. ^[4]

Discover accounted for around 1% of personal consumption expenditures (PCE) in each of the last five years and the improving consumer spending trends are likely to benefit the company. ^[5] Discover has also maintained market share of 5.3% to 5.5% of total revolving credit owned and securitized, outstanding across the U.S. for the last four years.

Despite the four consecutive months of increasing consumer spending, a Thomson Reuters/University of Michigan survey indicates that this trend reversed in September as consumer sentiment in the country dropped to its lowest level in five months due to the prospects of higher interest rates and slower economic growth. ^[3] However, Discover’s competitor American Express (NYSE:AXP) recently reported an 8% year-on-year increase in card-member spending for the three months ending September. American Express accounts for 4% of PCE in the U.S. and despite its inclination to target the affluent section of society, its results can be used as a barometer for the performance of other card companies. Visa (NYSE:V) and  MasterCard (NYSE:MA) account for 20% and 10% of the PCE in the U.S., respectively.

We expect Discover to maintain the volume and loan growth rate observed in the first half of the year.

Direct Banking

Discover is also expanding its direct banking services, offering personal loans, student loans and home loans. The company acquired Citigroup‘s (NYSE:C) student-loan portfolio in September 2011 and the Home Loan Center business from Tree.com in June last year. Discover reported 5% growth in student loans through the first half of the year while personal loans grew from $2.9 billion at the end of the second quarter of 2012 to $3.6 billion with interest yield improving from 6.49% to 6.52%. Discover home loans, launched in June last year, originated $1 billion in direct mortgages in the three months ending June. The direct banking business currently accounts for just 10% of Discover’s revenue, but we expect further growth in the coming years.

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1. Current Events Calendar, Investor Relations [↩]
2. Consumer Spending in U.S. Climbs 0.3% as Incomes Pick Up, Bloomberg [↩]
3. U.S. consumer spending rises as wages boost family income, Reuters [↩] [↩]
4. U.S. Department of Labor, Labor Force Statistics from the Current Population Survey [↩]
5. Personal Consumption Expenditures, U.S. Department of Commerce: Bureau of Economic Analysis [↩]