Discover Financial Services DFS reported third-quarter 2015 earnings per share of $1.38 that beat the Zacks Consensus Estimate of $1.34. The bottom line also increased by a penny year over year.
The year-over-year improvement was primarily attributable to robust credit performance and share buyback initiatives that lowered share count.
Discover Financial’s total revenue, net of interest expenses was $2.2 billion, almost in line with the year-ago quarter. However, the top line surpassed the Zacks Consensus Estimate of $1.8 billion. Net interest income improved nearly 3% to $1.7 billion due to loan growth.
While total other income for Discover Financial decreased 8.9% from the prior-year quarter to $503 million, total other expense increased 6.7% to $882 million. The decrease in total other income was largely attributable to decline in protection products revenues and transaction processing revenues. Total other expenses, on the other hand, rose due to higher employee compensation and benefits as well as professional fees.
Segment Update
Direct Banking Segment
Discover Financial’s Direct Banking segment reported pre-tax income of $950 million, which reflects a 3% decrease from the year-ago quarter. This was due to an increase in expenses associated with anti-money laundering remediation. Revenues, net of interest expenses, for the segment was flat year over year.
The company’s card sales grew 2.6% year over year to $30.4 billion. Total loans increased 4% to $70.1 billion, mainly aided by a rise of 3.6% in credit card loans, 3.2% in private student loans and 12.3% in personal loans.
Expenses were up 8% to $838 million on increased regulatory and compliance costs.
Discover Financial’s credit card net charge-off rate decreased to 2.04% from 2.16% in the year-ago quarter. The over 30 days delinquency rate fell to 1.65% from 1.71%.
Additionally, provisions for loan losses declined $24 million year over year to $332 million. This reflects a lower reserve build than the year-ago quarter. Reserve build during the quarter was $8 million as against $32 million in the year-ago quarter.
Payment Services Segment
Pre-tax income at Discover Financial’s Payment Services segment decreased to $24 million from $28 million in the year-ago quarter. Revenues generated by the segment plunged 12% from that in the prior-year quarter to $68 million.
Payment Services transaction dollar volume fell 7% from the year-earlier quarter to $46 billion. The transaction dollar volume from PULSE decreased 11% year over year on account of loss of some volume from a large debit issuer. Network Partners’ volume surged 47% year over year, largely due to the AribaPay volume.
Operating expenses increased 14% year over year to $44 million.
Financial Position
Discover Financial had total assets worth $85.6 billion as of Sep 30, 2015, higher than $81.6 billion as of Sep 30, 2014. Total equity was $11.3 billion at the end of Sep 2015, almost flat year over year. Book value per share was $26.32 at the end of the third quarter of 2015 compared with $24.82 in the year-ago period.
Return on equity for the third quarter was 22%.
Share Repurchase & Dividend Update
During the reported quarter, Discover Financial bought back 8 million shares worth $435 million. This has led to a 1.8% sequential decline in shares outstanding.
On Oct 15, 2015, Discover Financial declared a quarterly dividend of 28 cents per share. The dividend will be paid on Nov 19, to shareholders on record as of Nov 5, 2015.
Business Update
Discover Financial recently entered the Banking Industry Architecture Network to enhance the speed of delivery of new products and services. The insurer intends to achieve this through reduction of integration costs and facilitation of a service-oriented architecture for information technology in the banking industry.
Our Take
Discover Financial surpassed our expectation and improved year over year. Share buyback activity has been a key strength of the company and this quarter was also no exception. This ushered in a lower share count, thereby escalating EPS further.
Moreover, increased card sales volume continues to impress. However, the Payment Services segment was a drag and we are skeptical of an improvement in the near term.
Zacks Rank
Currently, Discover Financial carries a Zacks Rank #3 (Hold). Some better-ranked stocks from the finance sector are Regional Management Corp. RM, Ally Financial Inc. ALLY and Cash America International, Inc. CSH. While Regional Management sports a Zacks Rank #1 (Strong Buy), both Ally Financial and Cash America hold a Zacks Rank #2 (Buy).
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