Is Discover Financial Stock Fairly Priced?

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Discover Financial stock (NYSE: DFS) has lost roughly 12% YTD, as compared to the 19% drop in the S&P500 over the same period. Further, at its current price of $101 per share, it is trading 16% below its fair value of $120 – Trefis’ estimate for Discover Financial’s valuation. The credit card giant posted better than expected results in the second quarter of 2022, despite a 10% y-o-y drop in total revenues to $3.2 billion. It was mainly due to a drop in payments services revenues from $822 million to $57 million. The decline was because of an unrealized gain of approximately $729 million in the year-ago period, as compared to a $42 million net loss on equity investments in Q2 2022. That said, the negative growth was somewhat offset by a 15% y-o-y increase in digital banking revenues to $3.17 billion. It was primarily due to a 14% rise in the net interest income, which benefited from higher outstanding loan balances and improvement in the interest rates. Further, the noninterest revenues also grew 22% y-o-y to $557 million driven by an increase in discount/interchange fees and loan fee income. On the expense front, both the noninterest expense as a % of revenues and the provision for credit losses saw an unfavorable increase. Overall, the adjusted net income declined 35% y-o-y to $1.1 billion.

The company’s top line decreased 4% y-o-y to $6.1 billion in the first half of 2022. This was due to a 41% y-o-y drop in the noninterest revenues, partially offset by a 10% rise in the NII. On the flip side, the Discover card volumes and total network transaction volumes improved by 21% and 10%, respectively, on a year-on-year basis. Along with lower revenues, the firm also witnessed an uptick in expense figures. The provision for credit losses increased from -$230 million to $703 million, followed by higher noninterest expenses, leading to a 29% y-o-y drop in the adjusted net income to $2.3 billion.

Moving forward, we expect the NII and transaction volumes to continue their growth momentum in the subsequent quarters. Altogether, Discover Financial’s revenues are estimated to touch $12.7 billion in FY2022. Additionally, DFS’s adjusted net income margin, which increased from 10% to 44.3% in 2021, is expected to normalize to around 34% in the year. It will likely result in an adjusted net income of $4.36 billion and an annual EPS of $15.97. This coupled with a P/E multiple of just below 8x will lead to the valuation of $120.

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