Capital One is ready to move beyond its year of acquisitions, cut expenses and reward investors, according to Goldman Sachs analyst Ryan Nash.
Credit card stocks are in a sweet spot, according to Nash, who said in a report on Sunday that "valuations remain very attractive," and that he expected the group to "see further outperformance in 2013," because "credit losses remain below normalized levels" and "superior capital generation drives higher capital returns for the group, with payouts surpassing 100 percent for some."
With the nation's largest banks now submitting their 2013 capital plans to the Federal Reserve as part of the regulator's annual stress tests, Nash said that card lenders "are in the best positions for returning capital," as the group has "a higher starting point, with an average Tier 1 common ratio of 12.4 percent (banks are at about 10.0 percent) and this matters greatly for these stocks as the cards generate capital much more quickly than the banks (260 bps vs. 75-90bp at banks on an annual basis)."
Nash also sees further upside for the credit card lenders as the group continues to take market share from money center banks, including Bank of America, Citigroup, and JPMorgan Chase. For the 12-month period ended Sept. 30, Goldman Sachs said that Bank of America's credit card loan balances declined by 9 percent, while its total loans declined by 4 percent. For Citigroup, card balances were down 4 percent, although total loans grew by 3 percent. JPMorgan Chase saw its credit card loans decline by 2 percent while total loans grew by 4 percent.
Meanwhile, according to Goldman, American Express grew its card loans (and total loans) by 6 percent, while Discover Financial Services saw its credit card loan balances climb by 4 percent, while total loans grew by 10 percent. Capital One's credit card balances were down 1 percent, although total loans grew by 5 percent. Nash said that "COF should continue to show strong core underlying growth, but this would likely be masked by strategic run-off in mortgage and card."
Capital One Upgraded
Nash upgraded Capital One to a "buy," rating from a "neutral" rating, while increasing his price target for the shares to $75 from $65 and leaving his 2013 earnings estimate unchanged at $6.90. Nash raised his 2014 earnings per share estimate by 20 cents to $7.50.
Discussing the company's ability to sustain "a $7 earnings run-rate," Nash said that "further clarity of a path to (and above) $7 of earnings should help drive shares higher. While almost 25 percent of core loans are in run-off, because those loans tend to be lower yielding (mortgages), any mix shift (into card, auto) should make the headwind manageable. We estimate COF will need 11 percent growth over the next 3-4 years to offset the headwind; we view this growth as manageable."
This year will be one of continuing transition for Capital One, which made two major acquisitions in 2012, that were delayed by very long approval processes by the Federal Reserve and the Office of the Comptroller of the Currency. The company in February completed its purchase of ING Direct from ING Group for $6.3 billion in cash, plus 54 million Capital One shares, representing a 9.7 percent ownership stake. Capital One also completed a $1.25 billion common equity raise in March. Then in in May, Capital One purchased HSBC's U.S. credit card portfolio for $2.5 billion.
The ING deal included roughly $80 billion in deposits gathered over the Internet, along with $41 billion in loans, providing plenty of liquidity for the $28.2 billion in credit card loans acquired from HSBC.
Capital One will report its fourth-quarter results on Thursday after the market close, with analysts polled by Thomson Reuters estimating the company will report earnings of $1.61 a share.
A further catalyst for Capital One's shares, according to Nash, is "upside from capital returns. While 2013 is a transition year, we see room for a meaningful increase in 2014 ($2 dividend and $2 billion buyback)."
Capital One's shares closed at $61.99 Friday, trading for 8.8 times the consensus 2013 earnings per share estimate of $7.03. The consensus 2014 earnings per share estimate is $7.38.
American Express Downgraded
Nash downgraded American Express to a "neutral" rating from a "buy" rating, while keeping his price target for the shares at $65, saying he saw "limited upside to out-year estimates (consensus of $4.75 in 2013) given the challenging revenue environment."
American Express is set to announce its fourth-quarter results on Thursday after the market close, however, the company last Thursday preannounced fourth-quarter earnings of $637 million, or 56 cents a share, declining from $1.25 billion, or $1.09 a share, in the third quarter, and $1.192 billion, or $1.01 a share, in the fourth quarter of 2012.
The company announced it would eliminate 5,400 jobs, resulting in restructuring charges of $742 million, along with an additional $153 million in expenses for customer reimbursements, including "fees, interest and bonus rewards as well as an incremental expense related to the consent orders entered into with regulators last October."
The company reported total fourth-quarter revenue of $8.1 billion, meeting the consensus estimate.
Nash said "we see limited upside to out-year estimates (consensus of $4.75 in 2013) given the challenging revenue environment, and that "while growth from fee initiatives (targeting $3 billion) and international expansion should help, we believe these are already included in consensus and upside to spend volumes seems unlikely in the near term."
The analyst went on to say that "any further upside would have to come from additional expense cuts (beyond what has just been announced)."
Goldman Sachs estimates that American Express will earn $4.80 a share in 2013. Nash lowered his 2014 forecast by 10 cents to $5.30, "to reflect slower expected growth," which he expects to be in the range of 5 percent to 6 percent over the next two years.
Shares of American Express closed at $61.24 Friday, trading for 12.8 times the consensus 2013 earnings per share estimate of $4.77. The consensus 2014 earnings per share estimate is $5.27.
Discover Remains 'Top Pick'
Nash said that Discover Financial remained his firm's top credit card pick, reiterating his "buy" rating for the company, while raising his price target for the shares by $4 to $50.00. For its Nash estimates that Discover will earn $4.25 a share in fiscal 2013 (which ends on Nov. 29) and $4.40 a share in 2014.
The analyst raised his fiscal 2014 earnings per shareestimate by 10 cents "to reflect better growth," and said that "our slightly below consensus 2013 and 2014 estimates merely represent our more conservative reserve building forecasts."
Nash said "we see a clear path to $4.25 of EPS, as DFS drives best-in-class balance sheet growth and legacy credit costs stay lower for longer. Given DFS' excess capital position ($2.5bn) and robust capital generation (2.7 percent ROA expected in 2013), we see it as well positioned to return over 100 percent of its earnings in 2013 via repurchases and dividends."
Goldman Sachs expects Discover to raise its quarterly dividend by 6 cents to 20 cents, and also expects "continued robust repurchase activity." Nash said that "by year-end 2014, we estimate that DFS will accumulate approximately $5.4bn of 'eligible capital' that will be available for the company to deploy into repurchases, M&A, or organic growth." The analyst expects the buybacks to reduce Discover's share count by 9 percent.
—By TheStreet.com's Philip van Doorn
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