Capital One (NYSE:COF)
Presented: 4/19/2016, By Bi (Brian) Ge, Fang Liu, Siwei (Lerrisa) Li, Tianyu (Jack) Shen
Position: We own 100 shares with a cost basis of $73.13
Business Description
Capital One is currently traded at $71.66 and the company generates revenue from Credit Card, Consumer Banking, and Commercial Banking. As of December 31, 2015, Capital One is one of the nation’s ten largest banks based on deposits, largest online direct banking institution in the United States by deposits, and the fourth largest issuer of Visa and MasterCard credit cards in the United States based on the outstanding balance of credit card loans.
Industry Outlook
Capital One is identified as a major player in the credit card industry, holds 13.5% of the total market share. Credit card industry is a mature industry, is sensitive to macroeconomic environment, and is vulnerable to the cyber-attack. In the next five years, aggregated household debt, per capital disposable income, and prime rate are projected to increase, while unemployment stays stable.
Financial Analysis
For FY2015, the company’s revenue and net income were $23,413 million and $4,012 million. Credit card services contributed 62.28% of revenue, 58.67% of net income, and 41.28% of total loans held for investment in 2015. Over the past five years, the company’s net interest spread has remained stable at around 7%.The company’s loan to deposit ratio increased from 99% to 104%, which shows the aggressive strategy capital one is taking and indicates higher risk in the future. Capital one’s domestic credit card delinquentincreasedover the years, implying that the default rate increased a little. The company’s ROE decreased due to more outstanding shares issued.
Comparable Valuation
We selected American Express and Discover as the major comparable to Capital One,since both of them have credit card issuance as their main business and are similar in the market size to Capital One. We also included Ally Bank, who does direct banking and provides mostly consumer loans, as a comparable company. We weighted 20%, 60%, and 20% on implied stock price using comparable average P/E, P/Sales, and P/B respectively, to get the implied stock price as $86.75.
Residual Income Valuation
We projected the company will grow its total amount of loan at an average rate of 6% in the next five years, and the loan to deposit ratio will be around 118%. We also projected the provision for credit losses will increase to around 25%. We used 8% as the equity charge and 15% as the discount rate to determine the implied stock price from residual income equals to $84.47.
Recommendation
We recommend to hold Capital One given the uncertainty of the economy recovery and consumer spending power in the coming years, as well as the company’s risk strategy of lowering credit requirement for its new issued credit cards.