NEW YORK (
) -- The consumer credit space is rapidly evolving, with all major players working to grow their international business and also jump on the mobile payments bandwagon.
KBW analyst Sanjay Sakhrani rates
-- whose PayPal subsidiary in August signed a landmark deal with card lender and payment processor
Discover Financial Services
-- and eight other companies "Outperform," and on Friday said that third-quarter "earnings season looks to be solid for the companies within our coverage universe," as "operating indicators such as credit quality and volume trends still remain relatively positive and resilient."
Sakhrani said that KBW continues "to maintain an overweight bias in our ratings for most companies we follow in the sector," because of the good operating climate and because "valuations remain attractive relative to other financials."
With several of the stocks seeing very strong price performance, investor fears of a 2013 recession with the "
" looming, continued uncertainty in Europe and slowing growth in China, it's not unreasonable to expect a fourth-quarter dip for some of these names, but Sakhrani said that "industry growth trends and current portfolio dynamics of card issuers (i.e., cleaner and stronger core group of customers following the recession and better cardholder payment behavior) help to lessen any potential impact" of an economic slowdown.
"In terms of the potential effects of a Fiscal Cliff specifically," he said that "the associated implications (i.e., higher tax rate and dividend tax rate, etc.) are less of an impact for the cards/payments space (with possibly the exception of
) given these changes mainly effect the higher income side of the consumer demographic and the companies are generally not high-dividend-yielding stocks to begin with as share repurchases are the preferred avenue of returning capital to shareholders."
In the aftermath of the credit crisis, investors with short-term horizons have been tempted -- and in some cases made a lot of money, if their timing was right -- by heavily discounted banking names, including
Bank of America
, whose shares were trading for roughly half their book value at the beginning of 2012, and now trade for roughly 0.7 times tangible book value, despite rising 62% through Thursday's close at $8.97.
But Bank of America still faces major uncertainty, with mortgage putback demands rising 41% during the second quarter alone, to $22.7 billion, as of June 30, and although it is profitable, the company's earnings are relatively week, with an operating return on average assets (ROA) of just 0.52% for the 12-month period ended June 30, and a return on average equity (ROA) of 4.84%.
In another development related to the company's two large acquisitions in 2008, Bank of America on Friday announced a $2.43 billion
of a class action lawsuit related to its purchase of Merrill Lynch.
While the consumer finance plays trade at much higher multiples to book value -- and to earnings estimates, for that matter -- you get what you pay for, and names like Discover and American Express consistently achieve ROE well in excess of 20%.
The following are the nine consumer finance companies rated "Outperform" by Sakhrani, with third-quarter earnings previews or commentary on Discover, which has already reported its fiscal 2013 results. The names are sorted by ascending upside potential implied by KBW's price targets:
9. Alliance Data Systems
Alliance Data Systems
of Plano, Texas, closed at $142.07 Thursday, returning 37% year-to-date, following a 46% return during 2011.
The shares trade for 14.5 times the consensus 2013 earnings estimate of $9.81, among analysts polled by Thomson Reuters.
Sakhrani's price target of $156 implies 10% upside potential for ADS.
The consensus estimate is for the private label credit card lender, payment processor and rewards program administrator to report third-quarter earnings of $2.21 a share (excluding options expenses), increasing from $2.13 in the second quarter, and $2.16 during the third quarter of 2011.
Sakhrani expects Alliance Data Systems to report third-quarter operating earnings of $2.29 a share, with full-year EPS estimates of $8.54 for 2012 and $10.18 for 2013.
The analyst said that "ADS has seen strong momentum in the portfolio growth front following the acquisitions of the Pier 1 portfolio, the Bon-Ton portfolio, and most recently the Talbots portfolio," and that "while accretion to EPS from these acquisitions may not likely occur until 2013 due to the fair value accounting treatments of the acquired portfolios, we believe the steps have been a positive for the company and will help to achieve its stated goal of 20% yr/yr receivables growth in 2012."
Interested in more on Alliance Data Systems? See TheStreet Ratings' report card for this stock.
closed at $133.91 Thursday, returning 33% year-to-date, following last year's 45% return.
The shares trade for 19 times the consensus 2013 EPS estimate of $7.16.
Sakhrani's price target of $150 implies 12% upside for Visa.
Analysts polled by Thomson Reuters estimate that Visa will report third-quarter earnings of $1.49 a share, declining from operating EPS of $1.56 during the previous quarter, but rising from $1.27 a year earlier.
Sakhrani estimates that Visa will report third-quarter earnings of $1.54 a share, with full-year EPS estimates of $6.50 for 2012 and $7.42 for 2013.
The analyst said that for Visa and
, third-quarter volume figures reported through August "suggest that volumes are trending in line to slightly better than our expectations for the quarter."
Sakhrani said "for Visa, we have incorporated 4% year/year total payments volume growth on a constant currency basis for C3Q12, which factors in the headwind on U.S. debitfrom the Durbin Amendment and compares to about 6% in C2Q12."
Sakhrani expects Visa's operating margin to improve to 59.2% in the third quarter, from 58.1% in the second quarter, and 57.2% in the third quarter of 2011.
Interested in more on Visa? See TheStreet Ratings' report card for this stock.
Shares of MasterCard closed at $452.17 Thursday, returning 22% year-to-date, following a 67% return during 2011.
The shares trade for 18 times the consensus 2013 EPS estimate of 25.60.
Sakhrani's price target for MasterCard is $525, implying 16% upside for the shares.
The consensus estimate is for MasterCard to report third-quarter earnings of $5.91 a share, increasing from operating EPS of $5.65 in the second quarter, and $5.63, during the third quarter of 2011.
Sakhrani estimates the company will report third-quarter earnings of $5.87 a share, with full-year EPS estimates of $21.82 for 2012 and $25.68 for 2013.
When discussing the effect of foreign exchange on the card processors' earnings, the analyst said "given that Visa hedges its FX exposure, this will mainly affect MasterCard's earnings." MasterCard's management provided updated FX impact guidance during its investment community meeting (which was unchanged from the guidance it gave on its 2Q12 earnings call).
"For MasterCard, we have incorporated 7% year/year GDV growth on a reported basis for 3Q12, which compares to 9% in 2Q12," he said.
Sakhrani expects MasterCard's operating margin to improve to 55.8% in the third quarter, from 54.6% in the second quarter, and 55.1% in the third quarter of 2011.
Interested in more on MasterCard? See TheStreet Ratings' report card for this stock.
eBay has seen its stock rise 62% year-to-date, through Thursday's close at $49.12. The shares returned 9% during 2011.
The shares trade for 18 times the consensus operating 2013 EPS estimate of $2.72.
Sakhrani's price target for eBay is $58, implying 18% upside for the shares.
The consensus among analysts is for eBay to report third-quarter operating earnings 54 cents, declining slightly from 56 cents in the second quarter, but increasing from 48 cents in the third quarter of 2011.
Sakhrani matches the consensus third-quarter operating EPS estimate, and estimates full-year EPS of $2.33 for 2012 and $2.72 for 2013.
The analyst said that "the main driver of the strong share performance following EBAY's 2Q12 earnings release was the strong operating trends in the Marketplaces segment. Overall, some of the monthly e-commerce growth indicators have suggested a continuation of the trends seen during 2Q12 into 3Q12 with ChannelAdvisor reporting SSS (same-store sales) growth of 28.2% year/year in July and 23.9% yr/yr in August.
He added that "international trends will likely continue to remain a swing factor in the performance of the segment given that the majority of the revenues come from geographies outside of the US, though we would note that e-commerce trends have generally been fairly resilient despite uncertainties in the global economy over the past couple of quarters."
Interested in more on eBay? See TheStreet Ratings' report card for this stock.
5. SLM Corp.
of Newark, Del., closed at $15.83 Thursday, returning 21% year-to-date, after returning 9% during 2011.
The shares trade for less than seven times the consensus 2013 EPS estimate of $2.32.
Based on a quarterly payout of 12.5 cents, the shares have a dividend yield of 3.16%.
Sakhrani has a price target of $19 for SLM, implying 20% upside.
The analyst consensus is for the student lender to report third-quarter operating earnings of 54 cents a share, increasing from operating EPS of 49 cents in the second quarter, and 36 cents, during the third quarter of 2011.
Sakhrani estimates that SLM will report earnings of 53 cents for the third quarter, with a full-year EPS estimate of $2.13 for 2012 and $2.27 for 2013.
The analyst said that third-quarter themes for Salle Mae include credit quality, since "in 3Q12, both the charge-off rate and delinquency rate ticked up sequentially, mainly due to some seasonality in its collections from a higher level of loans that have entered into repayment having a higher level of delinquencies," and capital management, as the company "increased its share repurchase program by an additional $400 million in 2Q12 and on the conference call noted that it had about 60% of its authorization remaining."
Sakhrani expects "$150 million in share repurchases in 3Q12, which compares to $341 million in 2Q12.
Interested in more on SLM Corp.? See TheStreet Ratings' report card for this stock.
4. American Express
Shares of American Express closed at $56.57 Thursday returning 21% year-to-date, following a 12% return during 2011.
The shares trade for 12 times the consensus 2013 EPS estimate of $4.73.
Based on a quarterly payout of 20 cents, the shares have a dividend yield of 1.41%.
Sakhrani's price target for American Express is $68, which would represent upside of 20%.
The consensus among analysts is for American Express to report third-quarter earnings $1.08 a share, declining from $1.15 the previous quarter, but increasing from $1.03 a year earlier.
Sakhrani expects American Express to report third-quarter earnings of $1.12 a share, and estimates that full-year EPS for 2012 will be $4.46, followed by EPS of $4.89 in 2013.
The analyst said that "the company has provider quarter-to-date through July worldwide billed business growth of 6% year/year on a FX-adjusted (constant currency) basis, which compares to 7% year/year reported (versus 9% FX-adjusted) in 2Q12 and our estimate of 5% on a reported basis in 3Q12," and that "given the lack of updated volume trends, we believe investors will focus on the trajectory of billed business growth throughout 3Q12, domestically and internationally."
Interested in more on American Express? See TheStreet Ratings' report card for this stock.
3. Discover Financial Services
Shares of Discover Financial Services closed at $39.71 Thursday, returning 66% year-to-date, following a 315% return last year.
The shares trade for 9.5 times the consensus 2013 EPS estimate of $4.18.
Sakhrani's price target of $48 implies upside of 21% for the shares.
Discover on Thursday reported earnings of $627 million, or $1.21 a share, for its fiscal third quarter ended Aug. 31, increasing from $537 million, or $1.01 a share, the previous quarter, and $642 million, or $1.18 a share, a year earlier.
The sequential earnings improvement reflected a $182 million release of loan loss reserves during the fiscal third quarter. During the previous quarter, the company released $110 million in reserves.
While earnings were down slightly from a year earlier, earnings-per-share were up, because of the company's share repurchases. Discover bought back roughly 10 million shares for $350 million during the fiscal third quarter. Total shares outstanding declined by 1.9% during the quarter.
Sakhrani estimates that Discover's EPS for fiscal 2012 will be $4.42, followed by EPS of $4.16 in fiscal 2013.
Interested in more on Discover Financial Services? See TheStreet Ratings' report card for this stock.
2. Wright Express
of South Portland, Maine, closed at $70.11 Thursday, returning 29% year-to-date, following an 18% return during 2011.
The company focuses on providing payment processing and management services to commercial and government fleets.
The shares trade for 15 times the consensus 2013 EPS estimate of $4.72.
Sakhrani's price target of $85 implies 21% upside for the shares.
The consensus among analysts is for Wright Express to report third-quarter earnings of $1.21 a share, increasing from a dollar in the second quarter, and $1.18 in the third quarter of 2011.
Sakhrani estimates that Wright Express will report third-quarter EPS of $1.12, with full-year EPS estimates of $4.10 for 2012 and $4.54 for 2013.
The analyst said that "Same-store sales were down 1% yr/yr in 2Q12, which compares to down about 0.5% yr/yr in 1Q12," and that "WXS noted on its 2Q12 earnings call that its larger clients remain cautious on the U.S. economy, but still expect to see modest growth. Given the economic uncertainty, we think investors are likely to remain focused on same-store sales trends for the quarter and beyond."
For the company's Other Payments segment, Sakhrani said that because of recent acquisitions and contract signings, KBW is "assuming 30% year/year volume growth in 3Q12, which compares to 48.5% year/year in 2Q12 and 83.5% year/year in 3Q11."
Sakhrani added that "WXS recently acquired Fleet One, a North American over-the-road (OTR) and local retail fueling business, from private equity firms LRR Partners and FTV Capital for $369 million in cash," and estimated "potential annual adjusted EPS accretion of between $0.20/share to $0.30/share (with the low end occurring over the near term and high-end over the medium term)."
Interested in more on Wright Express? See TheStreet Ratings' report card for this stock.
1. Capital One Financial
Capital One Financial
closed at $56.96 Thursday, returning 35% year-to-date, following a flat return during 2011.
The shares trade for eight times the consensus 2013 EPS estimate of $6.94.
Sakhrani's price target of $70 implies 23% upside for Capital One.
The consensus among analysts is for Capital One to report third-quarter earnings of $1.70 a share, increasing from 16 cents in the second quarter, when the company set aside reserves for the $27 billion U.S. credit card portfolio it acquired from HSBC, and also agreed to pay $210 million in refunds and fines, after entering into a settlement with regulators over the marketing of credit protection products. During the third quarter of 2011, the company earned $1.77 a share.
Sakhrani is way ahead of the consensus, estimating that Capital One will report third-quarter earnings of $2.12 a share, with estimated full-year EPS of $6.90 for 2012 and $7.01 for 2013. The analyst lowered his third-quarter estimate from $2.23 and his 2012 estimate from $7.01, "mainly to reflect the quarter-to-date credit quality trajectory and our revised assumption of there being some level of charge-offs associated with the HSBC US Card portfolio (vs. zero previously)."
The analyst said that "with many of the key hurdles behind the company, such as the closing of the two acquisitions, the $1.25 billion equity raise, ING's share sale, etc., we believe that COF is increasingly becoming a more transparent story," and that "while there are still some purchase accounting related impacts that are still working their way through the company (particularly on the credit quality front) ... we continue to view COF as our best idea in the space as it is currently trading at compelling valuations on both a relative (versus regional banks) and absolute basis.
"Going forward, we think the key to optimizing shareholder value will be clean and transparent earnings quarters and some form of capital management," he said.
Interested in more on Capital One Financial? See TheStreet Ratings' report card for this stock.
Written by Philip van Doorn in Jupiter, Fla.
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.