DFS Posts Solid 1Q Earnings

Zacks

Discover Financial Services (DFS) reported first-quarter 2013 earnings per share (EPS) of $1.33, surpassing the Zacks Consensus Estimate of $1.12. EPS also surpassed the year-ago quarter’s earnings of $1.21.

Moreover, Discover Financial’s net income improved 3.5% year over year to $673 million from $650 million. Net income allocated to common shareholders also increased to $659 million from $644 million in the year-ago quarter.

The improvement in Discover Financial’s net income was due to revenue growth and improved interest income. Strong operating results in the Direct Banking segment overshadowed the decline in pre-tax income of the Payment Services segment.

Discover Financial’s total revenue, net of interest expense, increased 10% year over year to $2.0 billion, beating the Zacks Consensus Estimate of $1.64 billion. Net interest income also improved 9% year over year to $1.41 billion.

Moreover, total other income for Discover Financial increased 14% over the prior-year quarter to $582 million. However, total other expenses also jumped 12% year over year to $753 million.

Direct Banking Segment

Discover Financial’s Direct Banking segment reported pre-tax income of $1 billion, reflecting a 3% increase from the year-ago quarter. Revenues, net of interest expense, for the segment amounted to $184 million, up 11% from the year-ago quarter. The increase was due to increased loans, additional revenues from Discover Home Loans, launched in Jun 2012, and decline in funding costs.

Discover card sales volume grew 4% year over year to $24.9 billion. Total loans improved 7% year over year to $60.4 billion, boosted by a 5% increase in credit card loans, a 6% increase in private student loans and a 21% surge in personal loans.

Other income increased 15% year over year, primarily due to higher interchange revenue owing to improved sales and additional revenues from Discover Home Loans.

Expenses in the segment surged 12% year over year on higher employee compensation and marketing expenditure related to the Home Loan Center acquisition, increased card marketing initiatives and elevated headcount.

The credit card net charge-off rate increased 5 basis points (bps) sequentially to 2.36%. However, the over-30-days delinquency rate declined 2 bps over the prior quarter to a record low of 1.77%.

The provisions for losses hiked $75 million year over year to $159 million, reflecting lower reserve release, which was partly offset by lower charge-offs. Reserve release during the quarter was $154 million, against $274 million in the year-ago quarter.

Payment Services Segment

Discover Financial’s Payment Services segment’s pre-tax income fell 2% year over year to $47 million. Revenues were up $5 million over the first quarter of 2012. Meanwhile, expenses increased $6 million from the year-ago level as a result of a surge in professional fees and marketing expenses due to the recent partnerships and other expansion initiatives.

Payment Services dollar volume increased 2% from the year-ago quarter to $48.8 billion. Meanwhile, the year-over-year growth rate of transaction volume from PULSE has reduced to 4% due to increased competition and merchant routing.

Financial Position

Discover Financial had total assets worth $76.14 billion as of Mar 31, 2013, increasing from $71.19 billion as of Mar 31, 2012. Total equity stood at $10.3 billion at the end of Mar 2013, up from $8.7 billion at the end of Mar 2012. Book value per share was $20.90 at the end of Mar 2013, compared with $16.41 as of Mar 31, 2012.

Share Repurchase Update

During the reported quarter, Discover Financial repurchased 6 million shares for $238 million under its $2.4 billion share repurchase program.

Discover Financial has changed its reporting period from this quarter. As a result, the company’s fiscal year now ends on Dec 31, rather than Nov 30.

Zacks Rank

Currently, Discover Financial caries a Zacks Rank #2 (Buy). Other companies worth considering in the financial sector are Encore Capital Group, Inc. (ECPG), Credit Acceptance Corp. (CACC) and Total System Services, Inc. (TSS). All these companies also carry a Zacks Rank #2 (Buy).

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