Cash or Credit? Why Not Both? Part II

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

Just in case you didn’t like the more traditional credit cards that I recommended in the first part of this article, here are some other, less well-known credit card companies that offer compelling investment opportunities. These are Fleetcor Technologies (NYSE: FLT), Discover Financial Services (NYSE: DFS) and Capital One (NYSE: COF).

Although some of them offer other services and products besides credit cards, this business still accounts for most of their revenue. Trading at lower stock prices than the more “mainstream” companies, these firms offer plenty of room for expansion and strong, fast-growing business models, therefore deserving a closer look.

Fleetcor Technologies: Services to commercial fleets

Fleetcor Technologies provides specialized payment products and services to commercial fleets, oil companies and petroleum marketers in about 20 countries. Its core product is similar to a credit card that companies give to their employees for them to use to purchase gas and pay for accommodation and other business-related services and products. Over the years, the company has built a hard-to-match network of clients and merchants that has helped keep competitors lagging and has created incentives for new customers to turn to Fleetcor due to its wide acceptance and even wider customer base. Furthermore, switching costs are really high, even greater than in the case of credit cards; this provides the company with a wide moat that will continue to keep its peers from taking market share.

Fleetcor´s proposal is particularly attractive because customers can access discount fuel prices at most of the most important gas stations without carrying any cash. Going forward, expansion opportunities abound. International markets still remain widely unpenetrated. Over time the company has proven successful in the overseas expansion front, although strongly relying on acquisitions of smaller fleet card companies. However, these purchases have resulted in profitability for the firm. Over the last three years, the company has increased its revenue by an annual average rate of 26%, and its net income by 34.4%.

With industry-leading growth rates and strong results on the last reported quarter while expected to outperform its peers, delivering an average annual EPS growth rate of 16% (Zacks Estimate), this stock looks pretty attractive. Nevertheless, currently trading at 31.3 times its earnings, a 7% premium to the industry average, I would recommend holding. Although prospects seem promising, the fact is that valuation is quite above the industry averages and the firm´s dependence on fuel prices adds considerable unpredictability to its future. Moreover, its balance sheet is not so balanced, with over 50% of its total assets compounded by intangibles and goodwill and a relatively bulky debt level (0.5 in relation to its equity). Although some factors discourage me from recommending you to invest in this company at the time--principally, the stock valuation--I´d still advocate keeping a close eye on its stock performance; a decline in its stock price would quickly open an attractive entry point.

Discover Financial Services: Credit card business 

Discover Financial Services provides a wider array of services than other credit card companies, including loans and deposit products in its offering. However, it stands out for its credit card business; alongside American Express, Discover is the only firm in the U.S. that not only provides monetary transaction services, but also issues its own cards. In addition to its core credit segment, the company has developed a strong debit card network and has achieved agreements with huge third-party card issuers like Wal-Mart, dramatically expanding its client base. In the coming years, several important firms are expected to seek deals to issue Discover cards, mainly due to its wide product offerings.

Having recently purchased Diners Club International, Discover has been catching up to its main competitors, Visa, Mastercard and American Express, both in network scale and international presence. Going forward, agreements with PayPal (for mobile payments) and Google (for its Google Wallet), amongst others, should drive growth rates to new heights. Further growth opportunities seem soon to be available in China, Russia and India, where the firm is slowly and carefully making an incursion. Moreover, just like its peers, Discover seems poised to benefit from gradual abandonment of paper-based payment methods.

With a strong brand name, plenty of room for expansion ahead and above average net margins--74.1%--and returns on asset--3.2%--and equity--26.6%--while trading at 10.8 times its earnings, about half the industry average valuation, I would recommend buying this stock. Although analysts project an average annual EPS growth rate around 10% for the next five years to come, I feel bullish about Discover and believe that it could deliver higher figures than expected, providing plenty of upside for those investors who took the risk and bet on its prospects. Moreover, a strong cash position that should be bolstered by several ongoing capital growth initiatives will most likely continue to allow the firm to allocate funds at returning value to stockholders through its 1.69% projected dividend yield and continued share repurchase programs.

Capital One: A wide range of services 

Capital One also holds a wider product portfolio than traditional credit card companies. Although offering various products, including consumer and commercial banking services, its core, original business segment continues to rest on credit cards--accounting for 61% of the total revenue in 2012. Over the years, the company has expanded its credit card business through various acquisitions, including HSBC´s $30 billion U.S. credit card segment, and partnerships to issue cards together with industry-leading companies like Delta Airlines and Kohl´s. This strategy has helped Capital One gain a place amongst the five leading card issuers worldwide.

After the HSBC purchase, the firm started shifting towards higher-end card partnerships, divesting and selling out $7 billion of Best Buy credit card loans and keeping its deals with Neiman Marcus and Saks Fifth Avenue stores, looking to widen its margins and acquire better-performing debt.

Having proven successful in the past, keeping loan losses below the industry average by carefully choosing its customer targets (Morningstar), the growth years of Credit One´s credit cards segment seems close to the end. Going forward, growth will most likely be driven by its banking segments. The company seems to acknowledge the importance of diversification, having purchased several large banks over the last 8 years (including the Chevy Chase Bank and ING Direct USA, amongst various others), retrieving positive results. Through these risky acquisitions, the firm has accomplished a strong presence in  both traditional and online banking, and currently holds about 75 million client accounts.

Trading at 10.7 times its earnings, about half the industry average, while expecting an average annual EPS growth rate of around 10% (Zacks Estimate) and having offered above-average growth rates over the past few years, I’d recommend buying this stock. Moreover, a strong cash position will enhance shareholders’ value through share repurchase programs and a projected dividend yield of 1.96%, which reflects the first upsurge (by 500%) since the financial crisis.

Bottom Line

Above you will find a succinct analysis of three credit card companies that are a little less well-known than Visa, Mastercard or American Express, but still offer plenty of growth opportunities and are, usually, more conveniently valued. Offering compelling expansion prospects and entry points for investors, I’d recommend adding Capital One and Discover to your portfolio. These companies will not only deliver considerable upside, but also pay out juicy dividends during the process.

Fleetcor’s case is a little different. A few weeks ago, I had recommended buying these shares; however, at its current price, the stock seems a little overvalued for the upside it appears to offer. Don’t lose track of it, though; a decline in its stock price would quickly make of Fleetcor a buy again.

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