Capital One’s Improved Balance Sheet Enables More Returns
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Summary:
- Capital One’s strong financials include $1.8 billion net income, a single-digit P/E ratio, and robust liquidity with $132 billion in reserves.
- The company is acquiring Discover Financial Services, potentially enhancing synergies and creating its own payment network, despite integration risks.
- Credit card operations drive over 70% of revenue but also incur high loss rates; liquidity remains strong with a 163% coverage ratio.
- Shareholder returns are evident through significant buybacks and dividends, making Capital One a valuable long-term investment.
Heather Shimmin
Capital One Financial (NYSE:COF) is one of the largest bank holding companies, with an almost $60 billion market capitalization. The company is working through a massive acquisition of Discover Financial Services (DFS) – an all-stock acquisition, expected to close in the next 6 months. As we’ll see in this article, Capital One is a valuable investment opportunity.
Capital One Q3 2024 Highlights
Capital One had net income of $1.8 billion in the quarter, putting the company at a single-digit P/E.
Capital One Investor Presentation
The company managed to have $4.7 billion in pre-provision earnings, with $2.5 billion still set aside for credit losses. The company is working forward on a potential acquisition of Discover Financial, giving the company its own payment network. However, whether or not the acquisition still goes through remains to be seen.
The company has maintained a strong efficiency ratio and impressive operations.
Capital One Credit Loss Allowance
Among the largest expenses that banks and various firms operating in the industry will have, the major reason for interest charges, in the first place, is loss allowances.
Capital One Investor Presentation
The company has ~$16.5 billion in balance for credit losses, the vast majority of which is for the company’s credit cards (almost $13 billion). The company’s credit card allowance coverage ratio is just over 8% here. The company saw ~$2.6 billion in net charge-offs in the quarter and provisioned just under $2.5 billion.
That provisioning rate shows that the company is continuing to keep allowances near net charge-offs, which with the recent federal funds rate decline should be plenty for the company.
Capital One Liquidity
The company needs to maintain liquidity as a prime importance, especially given recent runs on banks.
Capital One Investor Presentation
The company has a 163% liquidity coverage ratio, up 8% QoQ with a massive almost $132 billion in liquidity reserves. The company has $49.3 billion in cash and cash equivalents, making up a big part of this. The remainder of this is in reliable investment securities. The company’s liquidity coverage ratio is something it can comfortably afford.
The company’s $353 billion in deposits, of which just over $60 billion are uninsured, means that it has very minimal risk in our view of anything happening with its liquidity. ~80% of the company’s uninsured reserves are covered by cash and cash equivalents, which shows the company’s overall financial strength.
Unfortunately, a decrease in interest rates means a hit in net interest income from this cash portion of the portfolio.
Capital One Financial Results
The company continues to maintain strong financial results from its business, versus its market cap of just under $60 billion.
Capital One Investor Presentation
The company continues to make the largest source of its income from credit cards, providing the company more than 70% of its total net revenue. It also is the largest source of the company’s expenses, as it continues to handle the more than 8% loss rate from this business. The company has also seen strength across its other segments, especially consumer banking.
At the end of the day, post taxes, the company saw almost $1.8 billion in income, giving the company a single-digit P/E. Those financial results show the company’s continued cash flow and ability to drive returns.
Capital One Shareholder Returns
The company’s shareholder returns are evidenced through its continued buybacks.
Macro Trends
The company announced a $5 billion buyback program in 2022, which enabled a ~10% reduction in shares outstanding. The company is down below 400 million shares. While we expect shareholder returns to be primarily halted pending the company’s merger with Discover Financial Services, outside of its dividend of just under 2%, the company’s financials remain strong.
The company sees the potential for synergies with Discover Financial, even given the double-digit premium on the acquisition. That cash flow makes the company a valuable investment, especially given its lower valuation.
Thesis Risk
The largest risk to our thesis is that Capital One is working to acquire a massive business, Discover Financial. Not only does the company need to successfully integrate that acquisition, but it’s pledging its successful credit card network paired with Visa to a less known payment processor. That could hurt the company’s future growth and ability to drive returns.
Conclusion
Capital One has an impressive portfolio of assets. The company is growing in the credit card space, and it maintains strong banking assets. The company’s net charge-offs, especially in credit cards, are relatively lofty. However, we expect those numbers to go down, especially as interest rates and charges to customers decline.
The company is going through a transformative acquisition with Discover Financial Services, which will give the company its own payment network. That will enable substantial potential synergies. Additionally, the company itself continues to generate hefty cash flow, which will enable shareholder returns. Overall, this makes the company a valuable long-term investment.
Let us know your thoughts in the comments below.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of COF, DFS either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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