Capital One is able to grow its business aggressively, while maintaining effective control of expenses and credit.
The company's expense discipline has historically led to better relative operating leverage.
It also boasts a talented management team, which has demonstrated its ability to manage well through multiple cycles.
Capital One (NYSE:COF) is a fast-growing regional bank that the market values as if it were still a specialty mono-line credit card lender. It is able to grow its business aggressively, while maintaining effective control of expenses and credit. Its expense discipline has historically led to better relative operating leverage even as the company expanded through acquisitions and asset purchases. Overall, COF remains a very attractive stock, and its re-rating is long overdue. The bank's well-diversified loan book is fully deposit-funded. While regional banks trade at 12-14x 2016 earnings, COF trades at only 10x 2016 estimates (S&P forward P/E 18.5).
Capital One also boasts talented management, which has demonstrated its ability to manage well through multiple cycles. While COF is an attractive investment, it is not without risks. The company is still seeing portfolio contraction, and is exposed to lower-quality consumer credits.
Balancing Market Share Gains and Risks
For 20 years, COF has balanced market share gains and risks consistently, rapidly expanding or pulling back depending upon pricing and projected risk-adjusted returns. For example, in 2015, the company observed that some of its card strategies, such as certain cash-back card products, were working, and it ramped up marketing and distribution costs accordingly. COF's management has been able to drive a steady 5% PPE yield on loans since 2012. With domestic card growth accelerating, the upcoming GE Healthcare asset purchase and the eventual likelihood of rising rates, there are good reasons to expect continued PPE/earnings growth.
Well-Capitalized
Despite an estimated $400 million in share repurchases in 3Q15, the company's tier 1 Risk-Based Capital Ratio increased by 10 bps Q/Q. In addition, COF's sizeable buybacks of $3.1 billion approved through June 2016 are expected to boost EPS, in spite of limited core growth. COF remains very well capitalized. The bank's common equity tier 1 ratio was above its 8% target under the Basel III fully phased-in advanced approaches method as of September 30, after share repurchases in 3Q reduced net common shares by 7.6 million, or 1%, from 2Q, and by 4% over the last year. Under the standardized approached, COF's Basel III common equity tier 1 ratio came in at 12.1% in 3Q15.
Robust Domestic Card Business
COF reported strong 3Q15 EPS of $1.98, beating the consensus estimates of $1.94 by 4 cents. Healthy loan growth, higher NIM, and lower expenses all contributed to strong results. Capital One's 3Q15 results were solid, healthier than a negatively skewed consensus following cautious comments on expenses and credit. Disappointing trends in the Commercial Bank segment somewhat weighed on the results, but the more important card business delivered solid results with industry-leading loan and volume growth, resilient margins, and lower-than-expected provision expense.
COF's domestic card business remains robust. The company continues to report strong, industry-leading loan growth and in-line credit metrics. It showed strong loan growth of 12% from the year-earlier 3Q in its U.S. credit card business, with relatively stable credit-quality measures and a smaller build of the loan loss reserve than in 2Q, leading to a significant quarter-over-quarter increase in EPS. The reserve increase in 3Q was $171 million, down from $283 million in 2Q.
COF's net interest margin increased by 17 bps Q/Q and remains in a good spot, as the U.S. cards are poised to gain a greater portion of the asset base and rising interest rates will increase yields on the other asset classes, i.e., commercial and auto. The impact of higher interest rates will not likely be felt until 2017 - management expects a lag before yields adjust. Analysts at UBS (report published on October 23rd, 2015) expect the asset mix change to benefit the NIM in 2016 with a 13 bps increase, followed by another 7-10 bps in 2017.
Conclusion
COF is a fast-growing regional bank that currently trades at a discount compared to core super-regional peers. I believe that Capital One could gradually re-rate to trade at the high end range of regional bank peers, given its above-average loan growth and capital return profile. The company continues to report strong results. The highlight of the most recent quarter was robust card growth, which continues to beat expectations and shows further signs of COF gaining market share. Over the last several quarters, COF has been accelerating in its breaking away from the competition.
Combined with an impressively stable and robust NIM, the bank's material market share gains are a key positive relative to its card lender peers, and ultimately, should drive outsized top line and EPS growth. It is worth mentioning here that credit loss reserve requirements depress GAAP earnings initially, but I think COF's industry-leading growth is driving true value creation and remains underappreciated.
No comments:
Post a Comment