Discover Financial Faces Concerns Over Remediation Reserve, Analysts Caution Despite Q1 Sales Growth

Discover Financial Services DFS shares are trading higher on Thursday. 

The company reported first-quarter revenue of $4.21 billion, net of interest expense, which was up 13% year-over-year. The total beat a Street estimate of $4.07 billion, according to data from Benzinga Pro.

Read More: Discover Financial Q1 Earnings Highlights: Revenue Beat, Charge-Offs Rise, Merger Update And More

Goldman Sachs analyst Ryan M. Nash highlights the company’s whopping $799 million charge related to the card misclassification remediation reserve in the quarter, which Discover Financial Services has incurred in the quarter under review.

In terms of credit, March metrics showed signs of improvement, with card DQs down -18bps month on month, outperforming seasonality by 12 bps while the year-over-year increase fell to +107bps versus +127bps last month (+135bps in Jan), the analyst notes.

Evercore ISI analyst John Pancari also flags Discover Financial Services’ sizable incremental customer remediation reserve.

According to the analyst, this is in addition to the company’s existing ~$370 million reserve related to the card misclassification/merchant tiering issue. 

Pancari reiterated an In Line rating on the stock, with price forecast of $140.

Wells Fargo analyst Donald Fandetti reiterated an Equal Weight rating on Discover Financial Services with a forecast of $135.

While Fandetti applauds the company’s core beat, he cautions about the company’s “large” remediation reserve.

Overall, an ~10.8x P/E is warranted given the optionality of the pending Capital One Financial Corporation COF acquisition, partially mitigated by the deal regulatory challenges and uncertain macro. 

The 10.8x is above the historical ~9-10x for card issuers, the analyst highlights.

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Price Action: DFS shares are trading higher by 3.25% to $123.82 on the last check Thursday. 

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