Discover Financial Maintains Growth With Diversification Paying Off

Discover Financial (NYSE:DFS) reported earnings for the fourth quarter of 2012 Thursday. The company, best known for its credit cards, reported a 6% increase in total loans, credit card loans and Discover card sales volume, leading to an 11% increase in revenues over the previous year. The management also announced a 40% increase in dividend payable to common shareholders. The earnings for the quarter and for the fiscal year were in-line with our expectations, and we will shortly update our model to account for the latest figures reported by the company.

Our $38 price estimate for Discover Financial is in-line with the current market price.

See our complete analysis of Discover Financial here

Credit Cards Leading The Way

Credit cards are Discover’s most important business, accounting for about 80% of the company’s revenues and gross profit. Around 66% of the revenues are derived from interest income from credit loans, with another 16% coming from discount fees charged from merchants accepting Discover cards. As we mentioned before, Discover saw a 6% increase in credit card loans and sales volume. However, the yield on credit cards declined by 20 basis points over the last year to 12.16%. This was due to an increase in promotional rate balances, coupled with a decrease in higher rate balances.

The company’s “Discover it” credit card product was well received in the trial phase, where it was released in a few select locations. Discover has announced plans to launch the product nationally in January 2013.

We expect Discover to maintain a 3% to 5% growth rate in sales volume and credit card loans over the next few years.

Growing Banking Business

Discover is trying to expand its direct banking business, it acquired Citigroup’s (NYSE:C) $2.5 billion student loan portfolio in September last year and the Home Loan Center business from Tree.com in June this year. The Discover Home Loans branch originated over $2 billion in loans since its inception in June. The company also disbursed over $1 billion in private student loans and $1.8 billion in personal loans, maintaining a net yield of 11.39%. We currently forecast a steady increase in student, personal and home loans. You can modify the interactive chart below to gauge the effect a change in forecast would have on our price estimate.

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