Stephanie Link: I'll Give Credit to Discover

NEW YORK (TheStreet) - I have followed Discover Financial  (DFS) since the days when it was spun off from Morgan Stanley  (MS) in July 2007.

It issues both credit and debit cards, provides other loans and operates one of four major payment networks that process and clear point-of-sale purchases in the U.S.  As I wrote in an earlier blog this week, recommending M&T Bank (MTB), I like the financials because I think the U.S. economy is on the mend, which will lead to higher loan growth, profitability and capital positions.

DFS is a well-run company with strong management, conservative lending practices, strong underwriting skills and an improving balance. I think the valuation gap between DFS and the other players will narrow over time as it continues to execute well. Currently it trades at a discount to the group at 11x vs. the sector average at 17.3x. Because of that, I see opportunity. 

I'm confident the company will continue to see solid loan growth and an uptick in margins in 2014 on top of the impressive 2013 results. Last year, the company posted strong results in its credit card division with 4% loan growth, which was at the high end of its 2% to 5% guidance and well above the 1% to 2% growth seen in the industry. This was driven by both an increase in wallet share/market share from existing customers (which grew 100 bps y/y) and new account growth (up 9% y/y). I expect as the economy improves, consumer confidence builds, momentum from its Discover It card (cash rewards program) and the focus on the prime revolver market that the results will continue to show improvement. At its analyst meeting late last month the company gave some details on recent trends, which support the momentum it is seeing, with 21% in application volume growth, 9% new account growth and 21% fewer customers with a balance transfer. Based on these trends and the improvement in the economy, I think 5% to 6% digit loan growth is doable, if not conservative.

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