Discover to Move to 100% Payout in 2013, Goldman Says

NEW YORK (TheStreet) -- Discover Financial Services (DFS) is an earnings juggernaut, and investors could see the company increase its payout to over 100% of earnings later this year, according to Goldman Sachs analyst David Nash.

Discover's shares closed at $39.15 Friday, trading for 2.2 times tangible book value, according to Thomson Reuters Bank Insight, and for 8.7 times the consensus fiscal 2014 EPS estimate of $4.50 a share, among analysts polled by Thomson Reuters. The consensus fiscal 2013 EPS estimate is $4.38.

While Discover's shares aren't cheaply priced to book value, they are trading low to consensus forward EPS estimates, considering the company's earnings power.

For fiscal 2012 ended Nov. 30, the credit card lender reported net income available to common stockholders of $2.3 billion, or $4.47 a share, increasing from $2.2 billion, or $4.06 a share, the previous year. The company's return on average assets (ROA) was 3.23% in fiscal 2012, and its return on average tangible common equity (ROTCE) was 26.8%, according to Thomson Reuters Bank Insight.

Those are strong numbers, reflecting just how wonderful the credit card business can be. The company earns money through thick and thin. The ROA has ranged from 1.20% to 3.43% over the past five fiscal years, while the ROTCE has ranged from 12.7% to 26.8%. For returns on equity, a weak year was fiscal 2010, when Discover set aside $3.2 billion for loan loss reserves.

And the valuation of Discover's stock to forward earnings puts it in some the same class as the "big four" U.S. banks, most of which can be expected to continue posting much weaker returns on assets and equity:

• Shares of Citigroup (C) closed at $42.68 Friday, trading for 8.2 times the consensus 2014 EPS estimate of $5.20. Leaving aside 2008, when Citi lost $27.7 billion, the company's ROTCE has ranged from negative 1.33% to 8.04% over the past four years, according to Thomson Reuters Bank Insight.
• Bank of America (BAC) closed at $11.76 Friday, trading for 9.1 times the consensus 2014 EPS estimate of $1.29. The company's ROTCE over the past five years has ranged from a negative 1.75% to 8.20%.
• Shares of JPMorgan Chase (JPM) closed at $48.63 Friday, trading for 8.4 times the consensus 2014 EPS estimate of $5.77. JPMorgan's ROTCE over the past five years has ranged from 6.89% to 15.26%.
• Wells Fargo (WFC) closed at $34.88 Friday, trading for 9 times the consensus 2014 EPS estimate of $3.89. Wells Fargo has been the strongest earner among the big four, with ROTCE ranging from 8.97% to 18.02% over the past five years.

Nash rates Discover a "conviction buy," with a $50 price target, and on Tuesday said in a report that the company "had the strongest January" among the major U.S credit card lenders, as its annualized ratio of net charge-offs to average loans declined by 36 basis points to 1.95%.

With credit worries behind the company, Nash said "we foresee DFS returning close to 100% of its capital generation in the form of a higher dividend" by the end of 2013. He expects the company to increase its quarterly dividend by $0.06 to $0.20 a share, and also expects Capital One to repurchase $1.9 billion worth of common shares in fiscal 2013, with another $2 billion in buybacks during fiscal 2014.

In support of such a high estimate for returns of capital, the analyst said Discover cited Basel III tangible common equity ratio of 13.1% "vs. banks at 8.6%."

Nash estimates that Capital One will earn $4.25 a share during fiscal 2013, with EPS rising to $4.40 in 2014.

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

DFS data by YCharts

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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.