Monday, June 29, 2009

Discover Financial (DFS) Surges on Analyst Upgrade

I've been taking a serious look at Discover Financial (DFS) the past 7-8 days as it seemed poised to break out of a recent range. Why buy a credit card company in these times? Why not - squiggly line analysis is all that matters to the computers. Profitability? Not in 2009 ... about a $1 loss estimated. 2010? Nah - not so much there either. But DFS is dirt cheap on 2012 earnings... and again, the computers have taken a liking to her and what HAL9000 likes we must chase into.

The stock has been under the 200 day moving average for a few months, after a false breakout in early May. Finally, Thursday it broke above the 200 day, which is typically when I'd jump in. Then Friday it broke right back below that key level, which is typically when I smack myself in the forehead. But an analyst came to the rescue with a positive note and $14 price target. Boo and Yah. Volume is nothing to get excited about - but we can say that about many stocks. So I'm seriously considering the stock here since I have a huge cash hoard and since green shoots abound for the US consumer and his propensity to pay back debt, what better place than credit cards, an area we've been bearish on for nearly 2 years. When stocks have nothing to do with earnings, we can buy at any price. Mmmmm.... Kool Aid.

Much like the banks who we lauded last quarter for great profitability (as long as you exclude that minor thing called a balance sheet) we can do the same for the credit card companies. Just ignore all the previous bad loans and look at current profitability - the Federal Reserve will come in with taxpayer backed dollars in case things ever get bad, and remember the Fed has created an environment where 4 year olds can run banks, borrowing at nearly nothing and lending at 5, 10, 15, 20%. Magic. It's good to be a financial co. in Cramerica!

Let's see what all the excitement is about today.
  • On the strength of some of its assets and the demographics of its credit portfolio, Discover Financial Services was upgraded by an analyst on Monday. Keefe, Bruyette & Woods Inc. analyst Sanjay Sakhrani upgraded his rating on Discover to "Outperform" from "Market Perform." He also increased his price target to $14 from $11.
  • In a research note, Sakhrani said if the company were to simply go into runoff -- a situation where it books no new business and lets outstanding balances be paid off -- and it liquidated its other divisions, its value would be more than its current share price.
  • Though credit quality is likely to continue to deteriorate into 2010, Sakhrani said those risks have been factored into his earnings estimates. Also, the credit-card lender's portfolio has less exposure to some of the hardest hit areas of the country, such as California and Florida. That means Discover's credit performance is likely to be better than other lenders. Its portfolio is also a bit older and had less growth during recent years, Sakhrani noted. The worst-performing loans across nearly all loan types were those originated during the past couple of years leading up to the recession. (but don't worry about all those prime loans about to go bad as unemployment continues to rise, followed by a period of jobless recovery)
  • Sakhrani also noted the strength of Discover's credit card and debit-card networks, which would be attractive assets to other financial institutions should the lender consider any deals when the economy starts to rebound. The company's networks are probably worth about a combined $1.5 billion, Sakhrani wrote in the note. The networks could be attractive for a bank that already issues cards, but wants to build a network. It could also be attractive for another firm looking to just cash in on the flow of transactions being completed through the network, Sakhrani said. (on that one I can agree because there is an oligarchy in the credit / debit transaction system - that said, it's not exactly a new catalyst and you'd think an interested party would of swooped in when the stock was 50% lower)
No position but squiggly line analysis says this is a strong consideration to buy on breakout

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