Acquiring Discover Will Create A Unique Global Payments Platform Serving Over 100 Million Customers

Key Takeaways

• The acquisition of Discover expands consumer banking capabilities and could enhance Capital One’s competitive positioning and revenue growth.
  
• Strong liquidity and improved net interest margins underscore potential revenue and earnings stability through strategic growth and efficient asset management.
  
• The termination of a key agreement, rising expenses, and regulatory uncertainties could pressure Capital One's earnings, margins, and financial 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 consumer banking and global payments platform with unique capabilities, modern technology, powerful brands, and a franchise of over 100 million customers, which can enhance competition and create significant value for merchants and customers. This could positively impact Capital One's revenue growth and earnings.
  
• Capital One's strategic emphasis on marketing and new account growth in the Domestic Card business, including targeting higher spend segments, suggests a focus on driving future revenue and improving revenue margins.
  
• The stabilization of credit trends in the Domestic Card business, alongside improved recoveries, suggests potential for maintaining or improving net margins by controlling future charge-offs and provisioning expenses.
  
• The company's strong liquidity position, bolstered by significant cash reserves and consistent deposit growth, ensures the ability to support loan growth and operational investments, likely benefiting future earnings stability and growth.
  
• The improvement in the net interest margin due to higher card and auto yields, along with effective asset sensitivity management, suggests potential for increased net interest income, positively affecting future revenue streams.

Capital One Financial Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Capital One Financial's revenue will grow by 17.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 15.3% today to 14.6% in 3 years time.
• Analysts expect earnings to reach $6.2 billion (and earnings per share of $16.01) by about December 2027, up from $4.1 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $7.4 billion in earnings, and the most bearish expecting $5.6 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.8x on those 2027 earnings, down from 17.0x today. This future PE is greater than the current PE for the US Consumer Finance industry at 11.7x.
• Analysts expect the number of shares outstanding to grow by 0.71% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.44%, as per the Simply Wall St company report.

Capital One Financial Future Earnings Per Share Growth

Risks

• The termination of the Walmart revenue sharing agreement has negatively impacted net charge-offs and contributed to a higher charge-off rate, potentially affecting future earnings.
  
• Overall higher card and auto yields may face headwinds if market interest rates decline, potentially impacting the company’s net interest income and revenue growth.
  
• An increase in noninterest expenses, particularly due to marketing and operational costs, could pressure net margins if revenue growth does not sufficiently offset these costs.
  
• There is uncertainty regarding the implications of the proposed CFPB late fee rule, which could significantly affect revenues and profitability if implemented.
  
• The pending Discover acquisition poses execution risk and regulatory approval uncertainties that could impact financial stability, capital actions, and future earnings.

Valuation

• The analysts have a consensus price target of $186.56 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 $232.0, and the most bearish reporting a price target of just $119.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $42.6 billion, earnings will come to $6.2 billion, and it would be trading on a PE ratio of 14.8x, assuming you use a discount rate of 8.4%.
• Given the current share price of $181.18, the analyst's price target of $186.56 is 2.9% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• 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.