Investors Should Pick Discover Over Capital One: Credit Suisse

NEW YORK ( TheStreet) -- Discover Financial Services ( DFS) and Capital One ( COF) trade at similar valuations, but Credit Suisse analyst Moshe Orenbuch sees Discover as the better pick for long-term investors.

Shares of Discover closed at $47.67 Tuesday and traded for 9.9 times the consensus 2014 earnings estimate of $4.83 a share, among analysts polled by Thomson Reuters.

Capital One closed at $61.81 Tuesday and traded for 9.3 times the consensus 2014 EPS estimate of $6.65.

Orenbuch on Wednesday reiterated his "outperform" rating for Discover, with a 12-month price target of $50.00.

The analyst stressed his preference for Discover over Capital One in a note to clients. "We continue to forecast better receivables and revenue growth in 2013-14," he wrote, adding that Discover's "credit risk profile remains stronger."

Orenbuch also prefers Discover because the company "will return the vast majority of earnings to shareholders," while Capital One is still digesting its huge 2012 acquisitions of ING Direct and HSBC's U.S. credit card portfolio.

Discover repurchased 6 million common shares during the first quarter, for $238 million, reducing its share count by 1%. The company has a $2.4 billion buyback plan in place. Based on a quarterly payout of 20 cents, the shares have a dividend yield of 1.68%.

Following the completion of annual Federal Reserve stress tests in March, Capital One received approval to raise its quarterly payout to 30 cents from 5 cents, but announced no plans to buy back any shares through the first quarter of 2014. Based on the 30-cent payout, Capital One's shares have a dividend yield of 1.94%.

Loan and Revenue Growth

Discover stood out among credit card lenders by reporting continued growth for its credit card portfolio during the first quarter, with average card balances increasing to $49.3 billion from $49.2 billion the previous quarter and $46.6 billion a year earlier. The annual growth rate was 6%. Here's how that compared to other big card lenders:
  • Bank of America's (BAC) credit card loan balances averaged $91.7 billion during the first quarter, declining from $98.3 billion in the first quarter of 2012
  • For JPMorgan Chase (JPM), average credit card balances declined to $123.6 billion in the first quarter from $127.6 billion a year earlier
  • U.S. Bancorp (USB) reported first-quarter average credit card loans of $16.5 billion, declining from $16.8 billion a year earlier
  • Wells Fargo (WFC) reported first-quarter average credit card loans of $$24.1 billion, increasing 9% from $22.1 billion in the first quarter of 2012
  • For Citigroup (C), average card loans increased to $146.2 billion in the first quarter from $141.7 billion in the first quarter of 2012, for a year-over-year growth rate of 3%
  • American Express (AXP) reported average loans of $62.8 billion in the first quarter, increasing 3% from $60.7 billion a year earlier
  • Capital One's (COF) average portfolio credit card loans increased to $78.4 billion in the first quarter from $61.5 billion a year earlier, however, the company acquired roughly $27 billion in card loans from HSBC last year, and transferred its $7 billion Best Buy card portfolio to held-for-sale in the first quarter. The sale of the Best Buy portfolio to Citigroup is expected to be completed in the third quarter.

From 2013 to 2014, Orenbuch forecasts Discover will grow its revenue by 5% and its assets by 4%. For Capital One, the analyst estimates a 3% revenue decline over the same period, with assets remaining flat.

Discover's first-quarter return on average total equity (ROE) was a very strong 27%, following ROE of 16% in 2011 and 20% in 2010. In comparison, Capital One's first-quarter ROE was 11.17%, following ROE of 10.00% in 2012 and 11.38% in 2011.

Capital One fares much better when returns on tangible common equity are compared, although Discover still comes out on top.

According to data supplied by Thomson Reuters Bank Insight, Discover's first-quarter return on tangible common equity was 29.73%, compared to returns of 31.87% in 2011 and 14.44% in 2010. For Capital One, the first-quarter return on tangible common equity was 17.98%, compared to 22.36% in 2012 and 24.15% in 2010.

Turning to credit quality, Orenbuch estimates Discover's ratio of net charge-offs to average loans will be "stable, lower than the industry average" this year at 2.4%, while Capital One's charge-off rate will be "above the industry average , increasing somewhat" to 4.5%.

Orenbuch also estimates that Discover will reduce its common share count by 7% this year and by another 7% in 2014. He expects Capital One's share count to be reduced by 1% this year and 4% in 2014.

The analyst estimates Discover will earn $4.80 a share this year, with EPS increasing to $4.90 in 2014 and $5.10 in 2015.

Orenbuch has a neutral rating for Capital One and estimates the company will earn $6.20 a share this year, increasing to $6.40 in 2014 and $6.75 in 2015.

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-- 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 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.