3 Credit Card Stocks with Big Upside Potential
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In 2008, several companies known as investment bank, or credit card issuers, applied to become banks for the purpose of securing government loans under the Troubled Assets Relief Program (TARP). While none of these companies discussed today is strictly a credit card issuer, all of them derive the majority of their assets through their credit card franchises. Margins on credit cards far exceed any other conventional bank loan, but so too do loan losses exceed those seen in conventional banks. The exception to this is American Express, which due to its strict credit underwriting standards has long enjoyed lower loss rates than its competitors.
American Express
American Express (NYSE: AXP) is an icon of the financial and business community in this country. Its stock was trading recently at about $49 per share. Its 52 week range is from $53.80 to $41.30, and it has a price to earnings ratio of 12.1. American Express has a market capitalization of $58 billion, and pays a quarterly dividend of $0.18, for an annual yield of 1.4%.
American Express continued its string of impressive quarters of a generally impressive year. In the fourth quarter of 2011, revenues were up 7% year over year to $7.74 billion, on the strength of higher spending by cardholders, and travel agency revenues. Profits for the quarter were up 12% year over year, to $1.192 billion, while the per share net advanced 15%, to $1.01. Overall in 2011, revenues advanced 9% to nearly $30 billion, and profits advanced 22%, to $4.9 billion, or $4.09 per share.
Looking ahead, not only will American Express continue to benefit from an improving economy, it has also placed significant bets on digital commerce. American Express mean analyst rating improved a tick to 2.1. Warren Buffet has owned American Express since 1964, and it is still 11% of his portfolio. I have written more at length before the recent earnings release about why I like American Express, and I look for 10%-15% growth each of the next two years, so that the company challenges its all time stock price of $66 by 2013.
Discover Financial Services
Discover (NYSE: DFS) was spun off as an independent company from Morgan Stanley, Inc. in 2007, at an initial average price of $30.19. It has not seen a stock price above $30 since 2007, but I believe 2012 will be the year. Discover's stock was trading recently at a little over $27 per share, near the high end of its 52 week range of from $28.09 to $20.23. Its price to earnings ratio is 6.8, and its market capitalization is $14.5 billion. It pays a quarterly dividend of $0.10 per share, for an annual yield of 2.5%.
Discover's fiscal year ended November 30, 2011. In that year, Discover posted earnings of $2.2 billion, a nearly threefold increase from 2010's $668 million. The 2011 earnings broke down to $4.06 per share, versus the $1.22 per share Discover earned in 2010. In the fourth quarter of 2011, Discover posted earnings of $513 million, versus $350 million in the fourth quarter of 2010.
I am left to wonder, with a company of Discover's obvious earnings power and momentum, why it is trading at a price to earnings ratio less than half of what the average stock is trading? First, there is litigation concerning coercive sales practices, and Discover has warned this may have an impact far greater than the $100 million that has already been reserved. Loans outstanding grew 17% from the beginning of 2011 until the end, and reserve provisions will need to be made for anticipated growth in 2012, as well. Further reserve reversals, which have been prevalent the last five quarters, are going to be only marginal at best in 2012, and earnings will suffer in comparison.
On balance, Discover has tremendous potential upside out to mid-decade, and the time to get on board is now, before the stock price catches up to the valuation of the company.
Capital One Financial Corporation
Capital One (NYSE: COF) is best known as one of the leading issuers of Visa Cards and Master Cards. But it also operates a major regional bank that is the nation's 14th largest commercial bank. The company has overall assets of about $205 billion. Capital One stock was trading recently at about $46 per share. Its 52 week range is from $56.26 to $35.94, and its price to earnings ratio is 6.76. It has a market capitalization of $21 billion, and pays a quarterly dividend of five cents per share, for a yield of 0.44%.
In its fourth quarter of 2011, Capital One reported earnings of $407 million, or $0.88 per share. This was down sharply from the $813 million, or $1.77 per share, reported in the year ago quarter. For all of 2011, Capital One posted earnings of $3.1 billion, or $6.80 per share, compared to 2010's earnings of $2.7 billion, or $6.01 per share. The disappointing recent quarter was largely due to the lack of one time events that helped prior quarters, such as the release of loan reserves. Margins also narrowed 17 basis points in the fourth quarter due to lower interest rates, and the company's non interest costs skyrocketed, due to its planned first and second quarter purchases of ING Direct for $9 billion and its $33 billion purchase of HSBC's (NYSE: HBC) U.S credit card business in the first and second quarters of 2012, respectively.
Those non interest costs will continue to grow in 2012, as the company does not anticipate the two mega purchases to contribute to profits until 2013. There will also be some share dilution and additional indebtedness to deal with in 2012. I like Capital One, and believe it well positioned to enjoy the 2013 – 2015 period, but expect a rough twelve months going forward.
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