Discover Acquisition Will Transform Consumer Banking And Payments

Key Takeaways

• The acquisition of Discover aims to create a leading platform with expected synergies to boost revenue and earnings growth.
  
• Strong marketing investments and credit management strategies are set to enhance revenue and stability in various business segments.
  
• Rising operational costs and charge-off rates, along with economic uncertainty, present substantial risks to Capital One's revenue growth and net income stability.

Catalysts

Operates as the financial services holding company for the Capital One, National Association, which engages in the provision of various financial products and services in the United States, Canada, and the United Kingdom.

• The acquisition of Discover is expected to create a leading consumer banking and payments platform with a focus on synergies over the next 24 months, potentially enhancing revenue and earnings growth.
  
• Strong marketing investments, particularly in technology-driven data and modeling, aim to capitalize on high-spending customers, potentially driving revenue and margin growth in the domestic card business.
  
• Continued favorable credit performance and a focus on credit management, including the release of $368 million in allowance, suggest potential improvements in net margins and earnings stability.
  
• Expanding international acceptance of the Discover network is anticipated to drive long-term revenue growth by leveraging global scale and increased transaction volumes.
  
• Growth in the auto business, driven by strong origination and loan volume increases, alongside improved credit metrics, is expected to support future revenue growth and earnings stability.

Capital One Financial Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Capital One Financial's revenue will grow by 18.5% annually over the next 3 years.
• Analysts are assuming Capital One Financial's profit margins will remain the same at 16.2% over the next 3 years.
• Analysts expect earnings to reach $7.4 billion (and earnings per share of $21.45) by about April 2028, up from $4.4 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $8.2 billion in earnings, and the most bearish expecting $5.9 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 13.4x on those 2028 earnings, down from 14.6x today. This future PE is greater than the current PE for the US Consumer Finance industry at 9.7x.
• Analysts expect the number of shares outstanding to decline by 0.16% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.24%, as per the Simply Wall St company report.

Capital One Financial Future Earnings Per Share Growth

Risks

• Capital One's revenue could be impacted by the 7% year-over-year decline in commercial banking revenue and the 2% year-over-year decline in consumer banking revenue, driven by margin compression. This highlights potential risks in maintaining revenue growth across different segments.
  
• The 13% increase in Domestic Card noninterest expense and a 19% increase in total marketing expenses year-over-year indicate potential risks to net margins if revenue growth does not keep pace with rising costs.
  
• The charge-off rate increased to 6.19% in the first quarter, primarily due to the end of the Walmart loss-sharing agreement, potentially indicating a risk to future earnings if charge-off rates continue to rise without offsetting growth.
  
• Capital One faces significant risks associated with heightened uncertainty and downside economic scenarios, including rising unemployment and renewed inflation, which could lead to higher credit losses and impact net income.
  
• The successful integration of Discover and achieving expected synergies remain uncertain, and any issues in the integration process or regulatory hurdles could impact Capital One's future earnings and strategic goals.

Valuation

• The analysts have a consensus price target of $206.872 for Capital One Financial based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $251.0, and the most bearish reporting a price target of just $160.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $45.6 billion, earnings will come to $7.4 billion, and it would be trading on a PE ratio of 13.4x, assuming you use a discount rate of 8.2%.
  
• Given the current share price of $170.2, the analyst price target of $206.87 is 17.7% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.