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Discover (DFS) Down 0.5% Since Last Earnings Report: Can It Rebound?

It has been about a month since the last earnings report for Discover (DFS). Shares have lost about 0.5% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Discover due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.

Discover Financial Q3 Earnings Miss on Higher Expenses

Discover Financial reported third-quarter 2023 adjusted earnings per share (EPS) of $2.59, which missed the Zacks Consensus Estimate by 17.8%. The bottom line dropped 26.8% year over year.

Revenues, net of interest expenses, of DFS climbed 16.1% year over year to $4,044 million.The top line beat the consensus mark by 2.5%.

The quarterly results received a blow from escalating operating costs and feeble contributions from the Digital Banking segment. Nevertheless, higher receivables growth, record deposit inflows and the solid performance of its Payment Services segment contributed to the upside.

Operational Update

Total operating expenses of $1,454 million escalated 6% year over year due to increased employee compensation and benefits expenses, marketing and business development costs, professional fees, and information processing & communications expenses. The figure came lower than our estimate of $1,546.9 million. Moreover, operating efficiency (total operating expenses divided by revenues, net of interest expenses) declined 350 basis points (bps) year over year to 36% in the third quarter.

Interest expenses increased more than one-fold year over year to $1,288 million in the quarter under review. Discover Financial’s net income of $683 million tumbled 33% year over year.

Segmental Performance

Digital Banking

The segment reported a pretax income of $803 million, which fell 37% year over year in thethird quarter. The decline was due to an increased provision for credit losses and elevated operating expenses, partly offset by growing revenues, net of interest expenses. The metric was lower than our estimate of $955.9 million.

Provision for credit losses increased more than one-fold year over year to $1,702 million.

Total loans rose 17% year over year to $122.7 billion in the quarter under review. Personal loans also grew 25% year over year. Credit card loans advanced 16% year over year, whereas private student loans improved 1% year over year.

Net interest income of $3,322 million climbed 17% year over year in the third quarter, thanks to increased average receivables partially offset by a lower net interest margin. The figure surpassed our estimate of $3,166.1 million by 4.9%. The net interest margin deteriorated 10 bps year over year to 10.95%.

Payment Services

The segment's pretax income was $85 million, comparing favorably with the prior-year quarter’s income of $32 million. The metric beat our pretax income estimate of $59.6 million by 42.6%. The significant improvement came from an increase in PULSE revenues. Expanding PULSE and Diners Club volumes also contributed to the upside.

The Payment Services volume of $91.8 billion advanced 9% year over year in the third quarter. The PULSE dollar volume rose 14% year over year on improved debit transaction volume.Meanwhile, the Diners Club volume climbed 11% year over year, attributable to continued strength in all regions. However, the Network Partners’ volume dipped 17% year over year in the quarter under review due to reduced AribaPay volume.

Financial Position (as of Sep 30, 2023)

Discover Financial exited the third quarter with total assets of $143.4 billion, higher than $131.7 billion at 2022-end. The liquidity portfolio (comprising cash and cash equivalents and other investments, excluding cash-in-process) amounted to $21.2 billion, higher than $19.8 billion at 2022-end.

Borrowings decreased from $20.1 billion at 2022-end to $19.5 billion. Total liabilities of $129.2 billion at the third-quarter end were higher than $117.4 billion at 2022-end. Total equity fell from $14.3 billion at 2022-end to $14.2 billion.

Share Repurchase Update

The company did not repurchase any shares in the third quarter of 2023. The management has decided to pause share repurchases as an internal review of corporate governance, risk management and compliance is taking place. The company bought back 18.1 million common shares worth $1.9 billion in the first half of 2023.

2023 Guidance

Management revised the loan growth to be in the mid-teens range for this year, from the earlier guidance of loan growth in the low mid-teens. In 2022, loan growth increased 20% year over year. The net interest margin is forecasted at 11%, in line with the 2022 reported figure.

Operating expenses are anticipated to rise in low double digits, unchanged from the previous guidance.

The average net charge-off rate is estimated to be 3.4-3.6%, unchanged from the previous guidance. The mid-point of the outlook stands higher than the 2022 figure of 1.8%.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed a downward trend in estimates revision.

VGM Scores

At this time, Discover has a subpar Growth Score of D, though it is lagging a bit on the Momentum Score front with an F. However, the stock was allocated a grade of A on the value side, putting it in the top quintile for this investment strategy.

Overall, the stock has an aggregate VGM Score of C. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, Discover has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.

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