One Reason Why Discover's Stock Price Was Dropping On Thursday


(MENAFN- ValueWalk) Shares of Discover financial Services (NYSE:DFS) were plummeting on Thursday after the credit-card issuer released fourth-quarter earnings that missed estimates .

While the company posted $4.2 billion in revenue , a 13% year-over-year increase, its net income plummeted some 61% to $386 million, or $1.54 per share. While it beat revenue estimates, Discover fell well short of earnings estimates.

Discover's stock price was down some 10% Thursday on the earnings miss, trading at around $98 per share, and there was one major reason why its earnings fell so sharply.

Higher provisions for credit losses drag down earnings

As stated above, the top-line number for Discover in the quarter was solid, as its revenue jumped 13% to $4.2 billion, with $3.5 billion of that total coming in the form of net interest income.

The credit-card issuer's interest income was up 26% year over year to about $4.9 billion as its total loans climbed 15% to $128 billion. Of that amount, credit-card loans accounted for $102 billion, a 13% increase over the fourth quarter of 2022. Offsetting that was a 77% increase in interest expense to $1.4 billion, but still, the net interest income gains were solid.

However, the big problem was deteriorating credit quality. The total net charge-off rate, which is loans that won't be repaid, rose 181 basis points (bps) in the third quarter to 3.52%, while the rate for credit card loans was even higher at 4.03% - up 211 bps. The delinquency rate also increased 130 bps in Q3 to 3.41%.

The third-quarter numbers had raised some red flags, but things got even worse in the fourth quarter . In Q4, the total net charge-offs were up 198 points year over year to 4.11% and 46 bps from Q3, while the credit card charge-off rate was 4.68%, up 231 bps year over year and 65 points from Q3. Further, the 30-plus-day delinquency rate for credit-card loans was 3.87% in Q4, which is 134 bps higher than it was in the year-ago quarter and 46 bps more than the previous quarter.

The deteriorating credit quality caused Discover to set aside $1.9 billion for credit losses in the quarter to cover losses it projects to have due to bad debt. That's up significantly from the $883 million provision in the fourth quarter of 2022. As that counts as an expense, it resulted in a huge drag on earnings. Combine that with operating expenses that were 18% higher in the quarter, and you have net income of just $388 million, down 61% from $1 billion in Q4 2022.

Outlook is not great

What spooked investors perhaps more than the fourth-quarter numbers was Discover's outlook for 2024. In its earnings presentation , Discover Financial officials said they expect the full-year net charge-off rate to be in the range of 4.9% to 5.3%. That is up significantly from the year-end net charge-off rate for 2023 of 3.42% - and up precipitously from 2021 when the rate was 1.82%.

If the projections pan out, it would indicate that Discover is anticipating difficult economic conditions and will likely have to continue to allocate substantial provisions for credit losses throughout the year, which will be take a bite out of earnings.

With Thursday's drop, the credit-card issuer's stock price is even cheaper than it was before, trading at just over 8 times earnings. However, given its outlook for credit quality and its guidance for its net interest margin to be in the 10.5%-to-10.8% range, down from 11%, it does not look like much of a bargain right now.

With the other major credit-card companies due to report their earnings in the next few weeks, it will be interesting to see how they fare and what their outlook is for 2024.

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ValueWalk

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