Capital One Ready for an Earnings Blowout: KBW

NEW YORK ( TheStreet) -- KBW analyst Sanjay Sakhrani believes Capital One Financial ( COF) has 38% upside for investors over the next 12 months.

The analyst on Tuesday reiterated his "Outperform" rating on the McLean, Va., credit card lender, following the completion of Capital One's acquisition of ING Direct on Feb. 17, and in anticipation of the company's purchase of HSBC's U.S. credit card portfolio, which is expected to be completed during the second quarter. Capital One will pay a $2.6 billion premium to acquire roughly $30 billion in credit card loans, and has the option to include $750 million in common shares as part of the purchase price.

Sakhrani raised his price target for Capital One's shares to $68 from $62, with the new target representing 38% upside from Monday's closing price of $49.38 Monday.

Capital One's shares have returned 17% year-to-date, following a flat return in 2011, which was actually a strong showing, considering that the KBW Bank Index ( I:BKX) dropped 25% last year.

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While the analyst left his 2012 earnings estimate for Capital One unchanged at $5.64 a share, he raised his 2013 EPS estimate to $6.77 from $5.53. That's a 22% increase for the year following Capital One's transformation through the two major acquisitions, and the new $68 price target, "derived by applying a 10x multiple to our 2013 EPS estimate," is rather cheap historically speaking, for a bank with a strong earnings track record.

Sakhrani cautioned that there were "clear overhangs on COF shares over the short run," including gaining approval from the Office of the Comptroller of the Currency for the HSBC deal, however, when the Federal Reserve approved the IGN Direct deal it had taken the subsequent HSBC deal into account, including the possibility of an issuance of common shares by Capital One. This bodes well for OCC approval, considering the stink that would be raised if that agency's view of the card portfolio purchase differed from that of the Fed.

Other overhang issues that could pressure Capital One's shares over the short haul, according to Sakhrani, include "a potential $1.25 billion equity raise related to the HSBC purchase," the possible sale by ING Groep ( ING) of "Some or all" of the 54 million Capital One shares it received when selling ING Direct, and "purchase accounting impacts that are likely to have net negative implications on 2012 GAAP EPS."

While KBW's 2012 EPS estimate for Capital One is a "core" earning estimate, Sakhrani believes that reported earnings for this year could be as low as $3.78, "based off of management's commentary at KBW's recent conference and its 4Q11 earnings call."

Citigroup analyst Donald Fandetti rates Capital One a "Buy," with a $58 price target, and on Monday pointed out that "of the total HSBC portfolio, $13B is private label, or $20 B when including co-brand," and that "combining this with COF's existing private label/co-brand portfolio of ~$6+ B (Kohl's, Hudson's Bay, Sony, etc) catapults them to the #3 player."

Fandetti said that with "several competitor contract expirations coming due over the next few years," Capital One is "in a position to bid on new private label portfolios."

The analyst calls Capital One his "top pick for 2012."

Interested in more on Capital One? See TheStreet Ratings' report card for this stock.

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

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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 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.