Consumer-Led Recovery Bolsters Consumer Finance Stocks

Written by GSCR Staff   
Wednesday, 27 November 2013 10:15

We have a lot to be grateful for this Thanksgiving.  Since 2009, the consumer has been largely credited with the economic rebound that we are enjoying.  The federal government bailout, new technologies, mobile payments and prepaid accounts have been changing the way we do business and, in our view, will change the way people pay around the world for the next few years.  In other words, micro foundations are changing the macro picture in a profound way.

Consumer finance companies, like Discover Financial Services (NYSE – DFS -$53.04), American Express (NYSE – AXP - $85.09), and Capital One Financial (NYSE – COF - $70.81), have benefited and supported this growth.  Not only have these companies enjoyed higher revenue and earnings growth than their peers in the financial sector, their shareholders have realized higher returns than those of the stock market and most stocks in the financial sector.

Both DFS and AXP reported a Return on Equity (ROE) approximating 24% for the first three quarters of 2013.  By contrast, COF realized an ROE under 8%.  So, let’s compare the prospects of DFS and AXP.

DFS is an online bank and electronic payment services company.  It offers Discover Card-branded credit cards, personal loans and deposit products to more than 50 million individuals and small businesses over the company's proprietary credit card network in the United States.  Its Payment Services segment operates the PULSE ATM/debit network, which serves more than 7000 financial institutions and includes over 900,000 ATMs, as well as point-of-sale terminals in 116 countries.

The stock has been performing well this year and it has good prospects to continue expanding its direct consumer finance and banking business for the next few years.  Steady loan growth and common stock repurchases have been key drivers behind its solid performance. Credit quality is also the best it has been in more than 14 years because it is applying higher credit standards since the recession. In addition, it has been boosting volumes by increasing market share and attracting new account sales.

AXP is a leading global service firm established in 1850. Its principal products and services are charge and credit payment card products and travel-related services offered to consumers and businesses worldwide.

As expected, AXP continues to benefit as consumers and businesses have been increasing their spending in a more stable economy. This trend could continue for the next few years. Spending increases along with a growing loan portfolio have been the key drivers bolstering net interest income and in turn AXP’s strong showing. AXP’s customers generally have good credit scores too. So, AXP has been reducing its loan loss provisions. In other words, while AXP’s near- and long-term prospects look sound, current valuations appear to fully reflect those prospects.

On a relative basis, we have a strong buy opinion on DFS shares because its stock has a more attractive valuation than AXP.  DFS shares closed near an all-time high at $53.04 yesterday. In other words, it trades at only 10.4 times the consensus 2014 earnings estimate. On the other hand, AXP shares look fully valued. Its stock hit an all-time high closing at $85.09 yesterday. It is trading at 15.7 times the consensus 2014 EPS estimate. 

The bottom line? DFS may be the best way to play the continuing rise in consumer finance stocks and a potentially higher growth economy.

Disclosure: Goldman Small Cap Research analysts are neither long nor short these shares but may elect to purchase the stock within the next 48 hours.

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