One thing is for sure, the Covid-19 lockdown certainly changed our lives and spending patterns. Some are saying, many of these changes are permanent, but I do not believe that. Remember after 9/11 almost nobody was flying on planes - but slowly, surely the plane filled up again. This virus will pass and life will return to normal.
Looking for opportunities
Spending patterns changed and should switch back - so I looked at the usual suspect - Visa Inc. (NYSE:V), Mastercard Inc. (NYSE: MA), American Express (NYSE:AXP) - but I think I found the best value in Discover Financial Services (NYSE: DFS). Here is what happened to their payment activity in the first 19 days of April:
Wow - travel down 99%, Gas down 60% Restaurants down 60%. Stunning, but reflects what each of us felt and observed during the lockdown doesn't it. And the drop in share price was just as stunning:
But what is happening now?
America and indeed the world is opening up again. Data from Apple and Google show our movement activity is returning to normal levels - people are no longer remaining locked up in their homes.
Restaurants are opening, gyms are opening, hairdressers are opening, beaches are open, the list goes on. Sure it is happening faster in some states than others, but it is happening.
Lets run through those spending categories referred to above in order of their % of 2019 sales:
|Category||% 2019 Sales||April 2020||Comments|
|Groceries||9%||16%||Will drop to normal|
You get the idea, they are all coming back except travel which only made up 8% of payments for Discover. Everything else, slowly but surely is coming back. Want some hard data - Apple shows driving activity is only 4% down now so gas consumption should be returning to normal:
So why hasn't the share price bounced back
There is the opportunity - the share price is bouncing back slower than activity. Probably because there is concern about people not paying their credit card bill similar to past recessions. Discover provided almost $1 Billion in the first quarter for such bad debts - note the provision is a book entry not an actual cash loss yet.
In past down turns, the Federal government has not given most people $1,200 to get them through, or supported small business to keep their workforce in tact. And this was an artificially imposed downturn for medical reasons - very different from past downturns.
But is Discover Financial Services (NYSE: DFS) a good business?
I believe it is - look at the financial metrics:
21.9% return on equity, 12.7% revenue growth, 14.4 % EPS growth, nice increase in free cash flow, etc. When you look at their Q1 credit metrics, you can see they were still in good shape:
A growing percentage of their funding comes directly from consumer which is more stable than brokers:
Loan growth is progressing nicely (Q1 drop in credit card loans is seasonal after Christmas)
Except for Diners Club payment volume is also growing nicely. Diners Club is mainly used outside of North America, so I am guessing the drop is caused by other countries being impacted by Covid-19 sooner.
With the Federal Reserve cutting interest rates, the Net Interest Margin (difference between the rate they lend money compared to the rate they pay on money they borrow) has dropped which is impacting their profitability. Similar effects will be felt by virtually all credit card companies and banks.
A lot of people do not realize everything Discover does:
- Credit Cards - readers in the USA know the Discover Card, international readers will recognize Diners Club.
- Payment Networks - they own the Pulse payment network used through a lot of ATMs
- Student Loans
- Personal Loans
- Home Loans
- Online Banking
Go and visit there website www.discover.com and check out their product offerings. They are very appealing and remember unlike a normal bank - they actually own the payment network as well. (Banks that issue credit cards do not own the Visa and MasterCard payment networks) so it is more like American Express in that regard. Except with a hipper client base than American Express.
Why we bought Discover Financial Services (NYSE: DFS)
Everybody raves about VISA and MasterCard (American Express not so much these days), but I think Discover's business is just as good and much better value. I strongly believe Covid-19 will pass and as things return to normal, so will the share price for Discover.
Not Investment Advice
As always, this is not investment advice. Do your own research. Consult your professional advisors.