- Discover Financial stock is up 33% YTD.
- It posted strong Q3 earnings Wednesday, with net income up 41%.
- Discover awaits approval of its potential merger with Capital One.
The credit card company charges ahead, with a potential merger with Capital One looming.
While it awaits approval of its merger with Capital One Financial (NYSE:COF), Discover Financial (NYSE:DFS) has been moving ahead with strong earnings and a rising stock price.
On Wednesday after the market closed, Discover posted third-quarter results that showed double-digit growth and easily topped earnings estimates.
The nation’s fourth-largest credit card company generated $4.45 billion in revenue in the quarter, which was up 10% year over year and beat estimates of $4.35 billion.
Net income surged 41% to $965 million, or $3.69 per share, which crushed estimates of $3.45 per share.
Discover stock was up another 2% on Thursday, and it is now up about 34% year-to-date, outperforming most of its competitors, other than American Express (NYSE:AXP).
The company continues to wait for a resolution in its merger with card issuer and bank Capital One. In the meantime, investors have been reaping the benefits of Discover’s strong performance. Is it too late to buy?
What’s Happening With the Merger?
Earlier this year, a megamerger in the credit card space was announced when Capital One said it was buying Discover.
This could be a transformative deal in the credit card space as it would bring together one of the largest banks and card issuers, with a payment processor, potentially creating a card company to rival Visa (NYSE:V) and Mastercard (NYSE:MA).
But this is a big, complicated deal with a lot of moving parts and major implications in the industry, so it has been under intense regulatory scrutiny and has faced legal challenges. When it goes through remains uncertain, although the companies have targeted late 2024 or early 2025.
In the Q3 earnings presentation, Discover officials said that merger applications are under review by the regulators and integration planning activities are advancing as anticipated.
Net Interest Income Rises
While Discover does offer some consumer banking services, it does not have the type of deposit franchise as its banking competitors. As it generates most of its revenue from interest income on its loans, Discover has been better able to take advantage of the high interest rate environment, since it has much lower deposit costs than most.
That has resulted in an increase in net interest income, something other financial firms have found difficult to achieve. Interest on its loans makes up most of its overall revenue, about 82%, so high rates have been a boon. In Q3, net interest income rose 10% year-over-year to $3.66 billion, or 10% year-over-year.
Further, its net interest margin (NIM) — which is the percentage of loan interest a bank gains after subtracting deposit costs — jumped to 11.4%, up 43 basis points year over year. This is ridiculously high compared to most banks, among which the average NIM is typically in the 3% range.
Net interest income was buoyed by a 4% increase in loans to $127 billion and higher yields on loans. The average yield on its credit card loans was 16.23% in the quarter, up 80 basis points from the same quarter a year ago.
Further, it saw non-interest income rise 13% year over year in the quarter to $77 million, boosted by a 4% increase in transactions on its networks.
Is it a Buy?
Investors who bought shares earlier this year got a nice return, but is it still worth the investment?
It is hard to say when the deal will go through, but until then, it should remain a favorable environment for Discover. Even though rates are trending lower, they are still very high relative to recent history, and the company forecasts the NIM to remain where it is, in the 11.2% to 11.4% range.
However, the firm did update its 2024 guidance on loan growth, and the outlook is slightly worse, with loan growth expected to be down low-to-mid single digits in fiscal 2024, down from previous guidance of loan growth being down low single digits.
The stock is also cheap, with a P/E ratio of 11, down from 14 in June.
Discover stock should still have some decent upside in front of it, at least until the merger happens.