Is Discover Financial Stock Attractive At the Current Level?

Discover Financial’s stock (NYSE: DFS) has gained approximately 7% YTD, as compared to the 8% drop in the S&P500 over the same period. Further, at its current price of $123 per share, it is trading 14% below its fair value of $144 – Trefis’ estimate for Discover Financial’s valuation. The credit card giant recently released its fourth-quarter results, beating the earnings estimates but underperforming the revenue consensus by a slight margin. It posted total revenues of $2.94 billion – up 4% y-o-y. This was driven by a 9% y-o-y rise in the digital banking division, thanks to the 4% increase in the net interest income (NII) and a 43% jump in the discount and interchange revenue. The NII benefited from some recovery in the net interest margin and a 2% growth in the average outstanding loans. Further, the card purchase volume grew roughly 25% in the quarter. Both these factors indicate improvement in consumer spending levels. Overall, the adjusted net income increased 34% y-o-y to $1.06 billion, leading to a quarterly EPS of $3.64.

The company’s total revenues increased 9% y-o-y to $12.1 billion in 2021. It was driven by a 6% rise in the digital banking unit coupled with a close to 100% jump in the payment services business. Notably, the company generates more than 90% of its revenues from the digital banking segment. The payment services benefited from growth in network volumes (up 21% y-o-y) and the number of transactions processed on the network (up 17% y-o-y). Similarly, the digital banking unit derived its growth from a 3% rise in NII and a 33% jump in discount and interchange revenue. Altogether, the above revenue growth translated into a 4x increase in the adjusted net income to $5.4 billion. This was mainly due to a favorable reduction in provisions for credit losses from $5.1 billion to $218 million.

The expected interest rate hikes by the Federal Reserve in FY2022 are likely to benefit the net interest income of lenders. Further, the consumer spending levels are likely to improve with recovery in the economic conditions. Overall, Discover Financial revenues are expected to touch $12.5 billion in FY2022. Additionally, DFS’s adjusted net income margin, which increased from 10% to 44.3% in 2021, is expected to normalize around 29.9% in the year. It will likely result in an adjusted net income of $3.7 billion and an annual EPS of $12.92. This coupled with a P/E multiple of just above 11x will lead to the valuation of $144.

Here you’ll find our previous coverage of Discover Financial stock, where you can track our view over time.

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[1] Month-to-date and year-to-date as of 3/1/2022
[2] Cumulative total returns since the end of 2016

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