Discover Financial Services, one of the most reputed brands in U.S. financial services industry, and one of the largest card issuers in the United States, released its financials for the fourth quarter of 2014 on 21st January, 2015. DFS provides an array of financial services such as home loans, private student loans, personal loans, home equity loans, checking and savings accounts, money market accounts through its direct banking business. However, the product that differentiates DFS from its peers is company’s proprietary Discover Network, which encompasses millions of merchant and cash access locations; Besides the Discover Network, the company takes pride in other leading produtcs like PULSE, one of the nation's leading ATM/debit networks, and Diners Club International -- a global payments network with acceptance in more than 185 countries and territories.
A bird’s eye view
On the fourth quarter results, David Nelms, Chairman and CEO of Discover, said “We delivered solid performance this quarter”. Overall, DFS reported a net income of $404 million as compared to $602 million i.e. a decline of almost 33% Y-o-Y. Despite this, total loans grew $4.2 billion (6.4% Y-o-Y), whereas credit card loans grew $3 billion (5.6% Y-o-Y). Now that I have given you an overview of the numbers, let us drill deeper to understand more about the performance of various segments.
Segmental break-down
The bottom line fell sharply from $911 million to about $700 million, or 30 percent Y-o-Y and 34.15% Q-o-Q from $981 million to $646 million. The primary reasons behind this decline is the previously announced $178 million one-time charge, related to the elimination of the credit card rewards forfeiture reserve, as well as a $27 million impairment of goodwill that was effected because of the acquisition of the Discover Home Loans platform. In short, credit card loans, ending loans, private student loans etc, have all grown Y-o-Y.
It is also significant for the investors to note that the net charge-off rate for credit card loans increased by 17 bps Y-o-Y & 10 bps Q-o-Q to 2.26%. This is an alarming signal for DFS, however on a positive note, the delinquency rate for loans over 30 days past increased by 1bps Y-o-Y & 2bps Q-o-Q to 1.73%. The expenses grew 10%, due to the impairment of goodwill, and other expenses like increased marketing spend, technological investments, etc.
This payment services segment fared quite poorly for the company in the reported quarter. The net income came in at at $2 million, down from $28 million Y-o-Y, and $26 million Q-o-Q. This was primarily due to $21 million fair value adjustment, resulting from classifying Diners Club Italy as held-for-sale.
The final words
On January 22nd, 2015, DFS closed on $57.32, down by $3.52 (5.79%) from the previous days close of $60.84 per share. This fall may be due to the adverse 4Q press release. However, the reasons for the fall in profits are primarily on account of the one-time charge, and the increase in the net charge-off. However, there is no reason directly attributable to the operations and the functioning of the Company. Although, on a positive note, Discover’s rivals, American Express Company (AXP, Financial) closed at $84.37 down $3.30 (3.76%), and Capital One Financial Corporation (COF, Financial) closed at $76.2 down $1.01(1.31%). This shows a trend of a general decline in the financial services sector.
On most fronts, the above analysis seems to be contradicting Mr.Nelms statement of a ‘solid performance’. However, the given shortfalls in the net income (both segment wise and total), are due to non-operating expenses, i.e. extra-ordinary items. Excluding these non-operating expenses, the company indeed has performed fairly well, and is a stock which one should consider buying. (Need further conviction in the stock, then take a look at the ratings by several research firms)
