Investment Perspectives Post Discover Financial's Q4 Earnings

Digital banking service provider Discover Financial Services (DFS) disclosed its fiscal fourth quarter results (ended December 2023) on January 17, 2024. The company’s fourth-quarter results witnessed a topline growth, outperforming Street estimates. Moreover, the company’s revenue has an impressive track record of surpassing Street estimates in three of the trailing four quarters.

However, despite the positive revenue surprise trend, the company experienced a staggering drop in its profits during the fourth quarter, falling short of analyst estimates for the same period.

On top of it, the provision for credit losses totaled $1.90 billion, significantly up from the previous year's $883 million. This escalation is attributed to the increased risk of default on mortgages and credit card debt by consumers, amplified by higher interest rates.

Meanwhile, the surge in total operating expenses was driven by higher employee compensation and professional fees, indicative of the company's investments in compliance and risk management.

While DFS struggles with compliance challenges, the company is proactively addressing the issue. DFS’ Interim CEO and President, John Owen, emphasized the implementation of measures to fortify its risk management and compliance programs. These strategic initiatives are expected to position DFS favorably, paving the way for the creation of significant shareholder value in 2024 and beyond.

Furthermore, despite the grim fundamentals, yesterday, the company’s board of directors approved a quarterly dividend of $0.70 per share of common stock payable to its shareholders on March 7, 2024.

The company’s annual dividend of $2.80 translates to a 2.55% yield on the prevailing prices, while its four-year average dividend yield is 2.34%. Its dividend payouts have grown at CAGRs of 15.3% and 12.5% over the past three and five years, respectively. Also, DFS has a record of 13 years of consecutive dividend growth.

In terms of price performance, the company’s shares plunged 9.7% over the past six months but gained 2.6% over the past month to close the last trading session at $108.74.

Here are the financial aspects of DFS that could influence its performance in the near term:

Mixed Financials

For the fiscal fourth quarter, which ended on December 31, 2023, DFS’ revenue net of interest expense increased 12.8% year-over-year to $4.20 billion. However, its total operating expenses rose 18.7% from the year-ago value to $1.78 billion.

Moreover, the company’s net income and EPS amounted to $388 million and $1.54, down 62.1% and 58.8% from the prior-year quarter, respectively.

Mixed Analyst Estimates

The consensus revenue estimate of $4.06 billion for the fiscal 2024 first quarter (ending March 2024) represents an 8.1% year-over-year improvement. Meanwhile, the consensus EPS estimate of $2.87 for the same period reflects a 19.8% year-over-year plunge.

Mixed Valuation

In terms of forward Price/Book, DFS’ 1.93x is 70.1% higher than the industry average of 1.13x. Likewise, the stock’s forward non-GAAP PEG multiple of 38.65 is significantly higher than the industry average of 1.46.

However, its forward Price/Sales ratio of 1.74x is 32.5% lower than the 2.58x industry average. Furthermore, its forward non-GAAP P/E ratio of 8.97x is 11.9% lower than the 10.18x industry average.

POWR Ratings Exhibit Uncertainty

DFS’ fundamentals are reflected in its POWR Ratings. The stock has an overall rating of C, translating to Neutral in our proprietary rating system. The POWR Ratings are calculated by accounting for 118 distinct factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. DFS has a C grade for Value, justified by the mixed valuation metrics. Likewise, the stock’s C grade for Stability is consistent with its 24-month beta of 1.22. Furthermore, DFS has a C grade for Sentiment, which is in sync with the stock’s mixed analyst estimates for the current quarter.

In the Consumer Financial Services industry, DFS is ranked #36 out of the 48 stocks.   

Beyond what we’ve stated above, we have also rated the stock for Growth, Momentum, and Quality. Get all ratings of DFS here.

Bottom Line

While DFS offers an attractive dividend yield and showcases resilience in its topline growth, the company’s future remains clouded by its continuous struggle with compliance, which is evident from its surging operating expense as a result of higher investments in compliance and risk management fees.

Furthermore, in spite of the CEO’s optimism, DFS’ mixed financials in the fourth quarter and mixed analyst estimates for the current quarter, pose a challenge for the company. In such a scenario, it might be best to wait for a more opportune entry point in the stock.

How Does Discover Financial Services (DFS) Stack Up Against Its Peers?   

While DFS has an overall grade of C, equating to a Neutral rating, you may also check out these other stocks within the Consumer Financial Services industry: Regional Management Corp. (RM), Qifu Technology, Inc. (QFIN), and World Acceptance Corporation (WRLD), with A (Strong Buy) and B (Buy) ratings. For exploring more Consumer Financial Services stocks, click here.    

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DFS shares were trading at $102.22 per share on Thursday morning, down $6.52 (-6.00%). Year-to-date, DFS has declined -9.06%, versus a -0.26% rise in the benchmark S&P 500 index during the same period.

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