Discover Financial seen advancing with industry tailwind

Discover Financial Services provides credit card customers with its own payment network.

By Katherine Hyunjung Lee

Analysts are optimistic about growth prospects for Discover Financial Services in 2017 as the company continues to post stronger than expected loan growth. The banking and payment services company based in Riverwoods, Ill., continues to expand its national footprint while riding on the growth tailwind of the credit card business.

Discover Financial’s stock price has been on the rise. When markets closed Thursday, shares were $70.99, up 45.4 percent from a year ago.

Of the 28 analysts surveyed by Bloomberg, seven give Discover Financial a “hold” or “neutral” rating and 20 give it a “buy” or “outperform” rating, with one “underweight” rating. The 12-month consensus target stock price is $79.88.

“It’s a very concentrated franchise,” Henry Coffey, Jr., an analyst at Wedbush Securities, said in an interview. “They’ve had one basic core mission for 20 years, which is to build out a credit card brand around prime, high quality borrowers that actually use the cards, that borrow money.”

Coffey has an “outperform” rating on Discover Financial and a target price of $80.

Increasingly, Discover’s competitors are turning to near-prime and subprime customers to ramp up loan growth.

“Issuance of credit cards in aggregate to near-prime and subprime customers has been increasing. There are a lot of people who are looking downscale,” Coffey said. “The real question is not loss ratios, but risk.”

“Discover Financial has begun to accelerate loan growth and maintain lending and operating margins,” Richard Shane, Jr., an analyst at J.P. Morgan, wrote in a note to investors Jan. 25, shortly after the company’s fourth quarter earnings announcement. “We see this as incrementally positive versus our prior expectations.

Shane gave Discover Financial a “neutral” rating following the earnings announcement. Discover beat J.P. Morgan’s estimate of $1.36 earnings per share at $1.40.

“Loan growth at [Discover Financial] remains notably below that of the peers we are recommending,” Shane wrote. “Further, we think tailwinds from the benign credit environment are likely to benefit all card issuers in the near term, not just [Discover Financial].”

Discover Financial’s stock price was $70.99 at market close Thursday, up 45.4 percent from a year ago. (Graph by Katherine Lee/MEDILL)

The credit card companies may be growing their business, but the industry remains a fiercely competitive one. Acquiring new customers is expensive, and companies must balance growth with reserve requirements and customer acquisition costs, as well as the interchange fees that are paid out to customers through rewards points.

Discover managed to reap benefits and save costs by turning its deposit gathering function into a full-service bank. Discover’s net interest income has been growing for eight consecutive quarters.

“They’re a branchless bank, with very profitable credit card products and other loan products,” Coffey said. “They’re not inhibited or held back by the heavy anchor or costs of the branch system.”

The company also promotes its own electronic payment network, which had once been viewed in the past as a valuable addition to the company’s business.

“It’s an important part of the business,” Coffey said. “But it’s a very small net contribution. It hasn’t changed how people are valuing the shares.”

According to the company’s filings, the number of transactions processed on the Discover Financial’s network have been rising year-over-year since fiscal year 2014, while network spending volumes have been fluctuating after reaching a peak in 2013.

Photo at top: Discover Financial Services provides credit card customers with its own payment network. (Photo by Katherine Lee/MEDILL)