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Credit Card Stocks are Hot Again: Goldman Sachs

NEW YORK ( TheStreet) -- Goldman Sachs on Friday upgraded its rating for Discover Financial (DFS - Get Report) to a "Buy" from a neutral rating, and upgraded the credit card sector to "Attractive" from "Neutral."

Discover on Wednesday reported net income of $624 million, or $1.18 a share, for its fiscal first quarter ended Feb. 29, increasing from $459 million, or 84 cents a share, a year earlier, and blowing past the consensus EPS estimate of 94 cents, among analysts polled by Thomson Reuters.

Discover's earnings beat was fed by a $226 million release of loan loss reserves, but the company also saw revenue net of interest expenses increases 6% year-over-year, with total loans growing 9% from a year earlier, to $56.3 billion, as of Feb. 29.

During the company's investor day presentation on Thursday, Discover's executives targeted annual earnings growth in a range of 10% to 15%, with a target return on equity of over 15%.

Following the completion of this year's Federal Reserve stress tests, Discover announced a $2 billion share repurchase authorization, while leaving its quarterly dividend unchanged, at 10 cents a share.

Discover's shares returned 35% year-to-date, through Thursday's close at $32.49. The shares trade for just over twice the company's reported Feb. 29 tangible book value of $15.82, and for just under nine times the consensus 20123 EPS estimate of $3.68.

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Goldman Sachs analyst Ryan Nash on Friday upgraded his firm's rating for the entire credit card space to "Attractive," from "Neutral," saying he saw further upside, as "we believe credit losses will stay lower for longer, driving EPS estimates higher," and that following the stress tests, "excess capital remains underappreciated." Nash also said that "low rates should push cost of funds lower and support margins."

The analyst also said that credit card lenders were trading at relatively low multiples to forward earnings, "at just 9.6x 2013 EPS vs. 12.4x for financials."

Nash upgraded his rating for Discover to a "Buy," from a neutral rating, while raising his price target for the shares by 8% to $39, while raising his fiscal 2012 earnings estimate to $4.05 a share from $3.60, and his 2013 EPS estimate to $3.90 from $3.55.

Nash added that after Discover completes its $2 billion buyback, "we still see $3bn of excess capital which the market is ascribing minimal value to at this point."

Interested in more on Discover Financial? See TheStreet Ratings' report card for this stock.
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