'Earnings Upside' for Discover: Guggenheim

NEW YORK (TheStreet) -- Guggenheim Securities analyst David Darst on Friday raised his price target and earnings estimates for Discover Financial Services (DFS), while pointing out that the stock valued "at the lower end of its three-year trading range."

Darst rates Discover a "Buy," and on Friday raised his price target for the shares by two dollars to $40, while raising his fiscal 2012 earnings estimate to $4.08 a share from $3.90, and his fiscal 2013 EPS estimate to $3.90 from $3.80. Discover's fiscal second quarter ended on May 31, and the company will announce its financial results on Tuesday.

During the fiscal first quarter, Discover reported earnings allocated to common stockholders of $624.4 million, or $1.18 a share, increasing from $458.4 million, or 84 cents a share, during the first quarter of 2011. Fiscal first-quarter earnings were boosted by a $226 million release of loan loss reserves.

Darst said that "recent credit data suggest credit will remain low and modest reserve release will continue given the current reserve represents 15.7 months" of net loan charge-offs at their fiscal first-quarter pace. The analyst expects "a reserve equal to 15.3 months in 2Q12," with a smaller "$0.06 per share benefit from release."

The analyst expects Discover to post fiscal second-quarter earnings of a dollar a share, declining from $1.18 in the first quarter and $1.09 in the second quarter of 2011, because of a decline in the reserve release, "however, operating income should increase 7%."

Discover's return on equity has been very strong, ranging from 25% to 33% over the past five quarters. Darst said second-quarter earnings "of $525 million should generate a 3% [return on assets] and 23.6% ROE," with an ROE of 22.3%, factoring out expected reserve release.

Guggenheim expects Discover's to set aside a total of $1.26 billion for loan loss reserves during 2012, increasing to $1.90 billion in 2013, but "we note a $200 million reduction to our 2013E provision would add $0.40 to our FY13E EPS."

Darst expects "a 7% increase in operating income" during Discover's fiscal second quarter, expecting operating income to grow by roughly 5% during fiscal 2012 and also during fiscal 2013. Discover on Tuesday announced the launching of Discover Home Loans, originating conventional fixed and variable rate mortgage loans, and FHA loans, following the company's acquisition Home Loan Center from Tree.com on June 6.

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