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Why Is Discover (DFS) Up 8.2% Since Last Earnings Report?

A month has gone by since the last earnings report for Discover (DFS). Shares have added about 8.2% in that time frame, outperforming the S&P 500.

Will the recent positive trend continue leading up to its next earnings release, or is Discover due for a pullback? 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 Lag on High Operating Costs

Discover Financial reported third-quarter 2022 adjusted earnings of $3.54 per share, which fell short of the Zacks Consensus Estimate by 3.3%. The bottom line was flat year over year.

DFS’s revenues — net of interest expenses — climbed 25% year over year to $3.5 billion in the quarter under review. Also, the top line outpaced the consensus mark by 3.6%.

The quarterly results were hampered by elevated operating costs at the Digital Banking segment. Nevertheless, solid loan growth, improved net interest margin and well-performance of credit metrics partly offset the downside. Strong contribution from the Payment Services segment also drove the upside.

Operational Update

Operating efficiency (total operating expense divided by revenues, net of interest expense) declined 300 basis points (bps) year over year to 39.9% in the quarter under review.

Total operating expenses of $1.4 billion escalated 17% year over year, mainly due to increased marketing and business development expenses, professional fees, and employee compensation and benefits.

Interest expenses surged 91% year over year to $514 million in the third quarter.

Discover Financial’s net income of $1 billion dropped 8% year over year.

Segmental Performance

Digital Banking Segment

The segment’s pretax income of $1.3 billion plunged 17% year over year in the third quarter. The decrease was due to rise in provision for credit losses and higher operating expenses, partly offset by improved revenues, net of interest expense.

The provision for credit losses of $773 million increased to more than four-fold year over year.

Total loans increased 17% year over year in the quarter under review, while our estimate for the metric indicates an increase of 12.6% from the prior-year quarter’s reported figure. While credit card loans advanced 19% year over year, total private student loans rose 2% year over year. Personal loans climbed 11% year over year.

Net interest income of $2.8 billion grew 18% year over year, courtesy of improved average receivables and an expanded net interest margin. Net interest margin improved 25 bps year over year to 11.05%.

Payment Services Segment

The segment reported a pretax income of $53 million in the third quarter against the prior-year quarter’s loss of $114 million. The segment’s performance gained on an unrealized equity loss of $167 million reported in the third quarter of 2021. Better PULSE and Network Partners volumes also contributed to the quarterly results.

Payment Services volume of $84.1 billion rose 10% year over year. While PULSE dollar volume increased 6% year over year in the quarter under review on the back of higher debit transaction volume, Diners Club volume witnessed a 34% year-over-year climb. Network Partners volume advanced 15% year over year, thanks to growing AribaPay volume.

Financial Position (as of Sep 30, 2022)

Discover Financial exited the third quarter with total assets of $121.9 billion, which grew 12% year over year. The liquidity portfolio (comprising cash and cash equivalents and other investments but excluding cash-in-process) dropped 20% year over year to $16 billion.

Borrowings stood at $20.2 billion at the third-quarter end, up 9% year over year. Total liabilities climbed 13% year over year to $107.6 billion. Total equity of $14.3 billion increased 8% year over year.

Capital Deployment

DFS suspended its stock buyback program in July 2022 due to an internal investigation of its student loan servicing practices. The suspension stays.

Shares of common stock outstanding dipped 0.7% sequentially.

The board of directors announced a quarterly cash dividend of 60 cents per common share, which will be paid out on Dec 8, 2022, to Discover Financial’s shareholders of record on Nov 23.

2022 Guidance

Management anticipates loan growth to be in high teens, up from the prior estimate of low teens’ growth. The average net charge-off rate is projected in the 1.8-1.9% range, down from the previous view of 1.9-2.1%.

Operating expenses are predicted to grow in high-single digits this year, up from the prior estimate of a rise in mid-single digits. Though the guidance for net interest margin is reiterated, the metric is likely to stay fairly above the upper end of the earlier projected range.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in estimates revision.

VGM Scores

At this time, Discover has a subpar Growth Score of D, however its Momentum Score is doing a bit better with a C. Charting a somewhat similar path, the stock was allocated a grade of B on the value side, putting it in the top 40% for this investment strategy.

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

Outlook

Estimates have been broadly trending upward for the stock, and the magnitude of these revisions looks promising. 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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