Why Is Discover Down 8.5% Since Last Earnings Report?

It has been about a month since the last earnings report for Discover DFS. Shares have lost about 8.5% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Discover due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.

Discover Q2 Earnings Beat on High Interest Income

Discover Financial reported strong second-quarter results supported by interest income growth, thanks to a high-interest rate environment, lower provision for credit losses, growing loans, PULSE volumes and margin expansion. The positives were partially offset by higher expenses.

It reported second-quarter 2024 adjusted earnings per share of $6.06, which comfortably beat the Zacks Consensus Estimate of $3.06. Also, the bottom line jumped 71% year over year.

Discover Financial's revenues, net of interest expenses, climbed 17% year over year to $4.5 billion. The top line also beat the consensus mark by 9.1%.

Q2 Operational Update

Interest income of nearly $5 billion jumped 16% year over year and beat our model estimate of $4.9 billion. Interest expense increased 30% year over year to $1.45 billion in the quarter under review but remained below our model estimate of $1.49 billion. Non-interest income jumped 45% year over year to $1 billion and beat the Zacks Consensus Estimate by 41.6%.

Total operating expenses of $1.7 billion escalated 23% year over year due to increased employee compensation and benefits expenses, professional fees, information processing & communications costs and other expenses. The figure came higher than our estimate of $1.5 billion. Moreover, operating efficiency (total operating expenses divided by revenues, net of interest expenses) deteriorated 190 basis points (bps) year over year to 38.1% in the second quarter.

Discover Financial's net income of $1.5 billion surged 70% year over year.

Q2 Segmental Performance

Digital Banking

The segment reported a pretax income of $1.8 billion, which rose 63% year over year in the second quarter. The increase was due to lower provision for credit losses, growing revenues, net of interest expenses, partly offset by elevated operating expenses. The metric beat the consensus estimate by 105.1%. Provision for credit losses declined 43% year over year to $739 million.

Total loans rose 8% year over year to $127.6 billion in the quarter under review. Personal loans also grew 13% year over year. Credit card loans advanced 7% year over year, while private student loans declined 1% year over year.

Net interest income of $3.5 billion climbed 11% year over year in the second quarter thanks to increased average receivables and net interest margin. The figure surpassed our estimate of $3.4 billion. The net interest margin improved 11 bps year over year to 11.17%.

Payment Services

The segment's pretax income was $277 million, comparing favorably with the prior-year quarter's income of $70 million. The significant improvement came from an increase in PULSE transaction processing revenues and a favorable settlement of existing litigation. The metric surpassed the Zacks Consensus Estimate of $74 million.

The Payment Services volume of $99.3 billion advanced 11% year over year in the second quarter. The PULSE dollar volume rose 18% year over year on improved debit transaction volume. Meanwhile, the Diners Club volume fell 5% year over year, attributable to lower volumes in India and AribaPay. The Network Partners' volume decreased 22% year over year in the quarter under review.

Financial Position (as of Jun 30, 2024)

Discover Financial exited the second quarter with total assets of $150.9 billion, lower than $151.5 billion at 2023 end. The liquidity portfolio (comprising cash and cash equivalents and other investments, excluding cash-in-process) amounted to $22.4 billion, lower than $23.3 billion at 2023-end.

Borrowings decreased from $21.3 billion at 2023-end to $19.1 billion. Total liabilities of $134.8 billion at the second-quarter end were lower than $136.7 billion at 2023 end. Total equity rose from $14.8 billion at 2023 end to $16.1 billion.

Capital Deployment Update

Management has currently paused share repurchases through merger closing. The company declared a quarterly cash dividend of 70 cents per share and expects it to remain at this level.

Other Updates

Discover Financial entered into a definitive agreement in February 2024 to merge with Capital One Financial Corporation for $35.3 billion,and the integration planning efforts are on track. Capital One is likely to commit $265 billion in community benefit plan over five years to lending, philanthropy and investment if its acquisition of Discover goes through.

DFS has also agreed to divest its private student loan portfolio to The Carlyle Group Inc. and KKR & Co. Inc. for up to around $10.8 billion.

2024 Guidance (including private student loan divestment)

Management expects the loan growth to be down low single this year. The net interest margin is forecasted to be in the range of 11.1-11.4%.

Operating expenses are estimated to rise mid-single digits from $6 billion in 2023, excluding merger and card misclassification-related costs. The average net charge-off rate is estimated to be in the range of 4.9-5.2% for the full year. The estimate stands higher than the 2023 figure of 3.42%.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in estimates revision.

VGM Scores

Currently, Discover has an average Growth Score of C, however its Momentum Score is doing a bit better with a B. Charting a somewhat similar path, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of A. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending upward for the stock, and the magnitude of these revisions looks promising. Notably, Discover has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.

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