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Discover Beats Estimates by a Mile (Update 1)

Discover CEO David Nelms said the company "demonstrated solid performance," and that "Card sales and receivables grew in a challenging environment while credit quality continued to improve."

Nelms added that the company "successfully launched Discover Home Loans in June, which expanded our direct banking product suite. In payments, we signed agreements with PayPal, Industrial and Commercial Bank of China, and most recently Russian Standard Bank to enhance our global presence and leverage our existing infrastructure."

Discover's deal with eBay (EBAY) unit PayPal will allow the online payment service's customers to make purchases at the 7 million retail locations that currently accept Discover, beginning in the second quarter of 2013.

Discover said that its fiscal third-quarter return on equity (ROE) was 28%, which is a very solid number for any financial institution in any market. According to Thomson Reuters Bank Insight, the company's operating ROE ranged from 24.41% to 33.42% over the previous four quarters.

Discover's shares closed at $37.02 Wednesday returning 55% year-to-date, following a 31% return during 2011.

The shares trade for 2.1 times their reported Aug. 31 book value of $18.02, and for nine times the consensus fiscal 2013 Earnings estimate of $4.06 a share, among analysts polled by Thomson Reuters. The consensus fiscal 2012 EPS estimate is $4.24.

Earlier on Thursday Morning, Sterne Agee analyst Henry Coffey said his firm was expecting operating earnings of about a dollar a share, and was "assuming no reserve release in our estimates," but also said a reserve release "would not be surprising."

Regarding Discover's $200 million settlement and $14 million in fines over the market of credit protection products, Coffey said that "the company has set aside reserves in past quarters related to state based lawsuits and other related items tied to these products in past," and had recognized litigation related expenses of $90.8 million," during the fiscal second quarter.

Coffey rates Discover a "Buy," with a $40 price target.

Nomura analyst Bill Carcache also rates Discover a "Buy," with a $41, and said after the earnings announcement that the company's "3Q12 core EPS of $1.10 (excluding $0.23 of reserve releases and $0.12 of non-recurring litigation charges)" beat his estimate of $1.07, although it was "unclear how much of one-time litigation charges and reserve releases were incorporated in the consensus GAAP EPS estimate of $1.03."

Carcache said that Discover's fiscal third-quarter loan growth suggests "that the company continues to gain share in the total revolving credit market, which is growing at ~1% on a YoY basis."

Regarding Discover's net interest margin improvement and the inevitable end to the declines in funding costs, with the Federal Reserve's target federal funds rate in a range of 0 to 0.25% since the end of 2008, Carcache said that "Our analysis suggests that the company's NIM can remain relatively stable over the next several quarters even as credit-related and funding cost tailwinds moderate, and we believe there may be upside to next year's guidance as a result."

DFS Chart DFS data by YCharts

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

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.
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