This Credit Card Company is a Buy!

Piyush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The September unemployment report was recently released and came in better than expected; this was well received by the market. The unemployment rate slid to 7.8%, this was the lowest in the last four years. Over the last month, 114,000 jobs were added to the existing number. It’s a well-known fact that with a higher employment rate, both disposable income and consumer spending increase.

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US Consumer Spending data by YCharts

Upon taking a look at the economic indicators, we can see that consumer spending has increased by nearly 26% in the last year. The fact that people are spending more, makes me bullish on payment industry players like Discover Financial Services (NYSE: DFS).

Discover Financial is the fourth largest credit card service provider in the US. The company also services personal and student loans and additionally provides deposit products, but its core business remains credit and debit card servicing. The company has a geographically well diversified payment network which extends to 185 countries around the globe.

Discover Financial in its recent quarterly results reported an EPS of $1.21 which was nearly 18% higher than the market estimates. Sales via credit cards rose to $27.2 billion which was up 4% compared to the year ago quarter. The net interest margin swelled to 9.44% rising 0.18% and the net interest income rose to $133 million, which was an increase of 11% compared to last year’s quarter.

PULSE, which was acquired by Discover Financial in 2005, provides the parent company its electronic fund transfer services. In the current quarter, PULSE saw a massive 25% increase in revenues compared to the same period last year. Additionally, since 2010, PULSE has added 129 card issuers to its network, and it is due to this reason that nearly 85% of the ATMs in the US accept PULSE.

In a bid to beat market competition, and establish a competitive advantage, Discover Financial Services has entered into an agreement with eBay (NASDAQ: EBAY). The deal would allow PayPal users to pay for their retail purchases at stores accepting Discover cards. Likewise, Discover card users would be able to use their cards for online purchases. Both companies would charge their users each time they use this service. Analysts believe that this deal would be a cash cow for both companies, as their respective users would now have the added flexibility to make retail and online purchases using the same service.

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DFS data by YCharts

The company shares its market space with Visa (NYSE: V) and MasterCard (NYSE: MA). When looking at the stock returns of the three peers, over a period of 1 year, we can see that Discover Financial has been the best performer with 68% returns. Evidently, good financial results and the deal with eBay is driving the share price of Discover Financial Services.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>P/E</p> </td> <td> <p>PEG</p> </td> <td> <p>ROE</p> </td> <td> <p>Net Profit Margin</p> </td> </tr> <tr> <td> <p>Visa</p> </td> <td> <p>135.14x</p> </td> <td> <p>6.88x</p> </td> <td> <p>5.2%</p> </td> <td> <p>13.48%</p> </td> </tr> <tr> <td> <p>MasterCard</p> </td> <td> <p>27.17x</p> </td> <td> <p>1.44x</p> </td> <td> <p>36.1%</p> </td> <td> <p>29.69%</p> </td> </tr> <tr> <td> <p>Discover Financial</p> </td> <td> <p>9.22x</p> </td> <td> <p>0.86x</p> </td> <td> <p>26.6%</p> </td> <td> <p>30.92%</p> </td> </tr> </tbody> </table>

Discover Financial Services has the highest net profit margin amongst its peers. Additionally, the P/E and PEG ratios indicate that the company is the most undervalued investment option amongst the three. Analysts expect the EPS growth in the next five years to be around 10.7% and with an ROE of nearly 27%, financial metrics of Discover Financial Services look great to me.

The rise in the consumer spending will only drive up the revenues of DFS. The company has outperformed its peers and has reported stellar quarterly numbers. The deal with eBay is expected to be a huge positive for the company, and will be the key growth driver for Discover Financial Services. Additionally, the financial metrics suggest that the stock is still undervalued, and it is due to these reasons that I am bullish on Discover Financial Services.


PiyushArora has no positions in the stocks mentioned above. The Motley Fool owns shares of MasterCard. Motley Fool newsletter services recommend eBay and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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