Credit Cards’ Bright Future on Display at Discover Financial Services

The future of the credit-card industry seems bright when viewed through the lens of Discover Financial’s (NYSE: DFS) earnings report. The credit-card provider reported significant revenue and income growth in the numbers from September 30.

Revenues grew by $113 million during the third quarter of 2016, and by $375 million in the year that ended on September 30, 2016. Discover reported revenues of $8.571 billion in September 2015, which grew to $8.833 billion in June 2016 and $8.946 billion at the end of third quarter.

The net income at DFS grew by $129 million in the year that ended on September 30. It rose from $2.201 billion in September 2015 to $2.303 billion in June 2016 to $2.33 billion for the latest earnings’ report. Despite that the net income still has not returned to $2.521 billion peak it reached in September 2014.

Why is Discover doing so well?

These numbers; and the 27.77% profit margin reported on September, show that Discover’s decision to concentrate on providing basic credit card services and good customer service is paying off.

By ignoring flashy gimmicks and avowing entanglements with retailers; such as American Express (NYSE: AXP) messy relationship with Costco, Discover has been able to maintain steady market share. It has also accumulated a lot of street cred and good will along the way.

A survey by Brand Keys found that Discover had become America’s favorite credit card brand in April 2016. The value from that reputation is immeasurable because it can lead to vast amounts of word of mouth advertising. That’s far more effective; and much cheaper, than paying A-list movie stars like Samuel L. Jackson to peddle credit cards on TV.

Avoiding the trap of exclusive deals with retailers helps preserve that reputation. All Citigroup (NYSE: C) seems to have gotten for its deal with Costco Wholesale (NASDAQ: COST) seems to be a lot of pissed off customers and declining revenues.

Citi’s revenues fell by $4.48 billion in the year that ended on September 30, 2016. The bank’s revenues declined by another $930 million in over third quarter 2016. Citi reported $75.8 billion in revenues in September 2015, $72.25 billion in June 2016 and $71.32 billion in September 2016.

It looks as if the resources Citi expended to have its MasterCard replace Amex at U.S. Costco stores have not helped the company. Perhaps those resources would be better expended on improved customer service.

Is Discover a Value Investment?

Growth alone does not make a company a value investment but cash does. Discover’s credit card business is not only profitable – it is generating a lot of cash.

Numbers from September 30 that prove Discover is generating a lot of cash include:

• A free cash flow of $1.271 billion.

• Cash and short-term Investments of $12.93 billion.

 

• $3.332 billion in cash from financing.

 

• $4.177 billion in cash from operations.

To this we can add assets of $90.54 billion and an enterprise value of $36.58 billion.

This looks like a classic value investment to me because the numbers prove Discover is a good company with a good business that generates a lot of cash. It is also not a very sexy company, all Discover does is issue credit cards and other financial products in the United States.

It lacks the glamour of American Express and the flashy technology of PayPal (NASDAQ: PYPL). Yet Discover is making a lot of money, and its business is growing that makes it a value investment.

Discover is an Income Investment

Discover is a very good value investment, because it is also an income investment.

DFS shareholders were rewarded with a dividend yield of 1.86% on November 9, 2016. They also received a dividend of 30¢ on November 1, 2016.

More importantly the DFS Dividend has been growing for the past few years. Discover investors received a dividend of 28¢ cents in 2015, 24¢ in 2014, 20¢ in 2013 and 10¢ in 2012. That means the dividend has tripled over the past four years which makes Discover a pretty good dividend stock.

To add icing to the cake DFS also offered a 21.64% return on equity on September 30, 2016. Meaning that investors reaped the rewards of higher dividends and increased share values.

Discover’s Bright Future

Discover’s future is pretty bright because today’s consumers want good basic financial products with great customer service which is what the company specializes in.

There are some interesting opportunities for growth out there. A big one is app-based financial services in the form of solutions like Apple Pay, Android Pay, Chase Pay and Walmart Pay. Discover supports Android Pay, Apple Pay and Walmart Pay; which is accepted at 5,000 Walmart stores in the United States.

That means people can already access their Discover Card balances through their phones using the three most popular payment apps in America. If that was not enough it would also be a very simple matter to integrate Discover with Chase Pay and with Samsung Pay. Neither of those apps currently works with Discover.

All this makes Discover a very good investment in the financial services and Fintech sectors. If you’re looking for a value and income investment in finance, check out DFS.