Shares of Capital One (NYSE:COF) continue to perform well

Capital One (NYSE:COF) is a powerful credit card company that recently announced its plan to acquire Discover Financial (NYSE:DFS). As the company builds a strong credit card portfolio and invests more in it future business, Capital One has a unique ability to generate long-term returns for shareholders.

Capital One Q2 2024 Highlights

Capital One had a strong quarter, despite missing expectations, with net income of nearly $600 million, giving the company a P/E of just over 20. The reason we’re calling it a strong quarter is because the company’s misses are due the impact of loan allowances. with higher for longer rates, however, in our view, the company’s core business continues to perform well. We also see massive benefits from the company’s acquisition of Discover Financial.

The company had to go on allocates significant cash to credit losses, which is not surprising given the company’s focus on credit cards. However, the company continued to maintain a strong efficiency ratio. It’s worth noting that the quarter also included a one-time allowance for the company’s loss from the Walmart program deal.

The company has been able to grow average deposits by 1% along with loans held for investments, and its price to book value is around 1.3x. The company’s Tier 1 capital ratio is 13.2%, well above the minimums, as the company continues to have minimal risk here.

Capital One allowance coverage rates

Below shows the specifics of the company’s allowance coverage rates in the credit card business.

The company had total net charge-offs of $2.6 billion, the vast majority of which occurred in its credit card business, which is known to be much riskier. The company still accrued $1.27 billion in net allowances, primarily due to the end of loss sharing with Walmart. His global balance here is $16.6 billion, which is pretty strong.

However, it is worth noting that we remain in an era of higher interest rates, which could affect the company’s losses going forward. The company has increased credit card allowance rates in particular as a result, but it’s still a real risk.

Capital One Interest income

The company’s NII for the quarter was just over $7.5 billion, with small margin improvements.

We’re actually pleased to see that margins remain flat. In a higher for longer perspective, competition between banks has increased much more than when rates were first raised. This has resulted in interest rates being offered to depositors and pressure on NII values ​​in general. In this market, Capital One has managed to excel.

Capital One Credit Card

Capital One is a $51 billion company by market cap with a growing capital ratio (13.2%).

The company must maintain certain capital ratios and, depending on its goals here and various tests, may pay shareholders dividends. This quarter, the company repurchased 1 million shares of common stock and paid its dividend of 1.78% for total shareholder returns of approximately ~2.5% annually. This is obviously a level that the company can afford.

However, it is a level we would like to see raised over time. However, we view Walmart’s growth as a unique factor, and the company’s P/E in a normal market to be closer to 15. At the same time, we see significant long-term potential from the Discover Financial acquisition, which will bring an internal payment processing network of one of the largest credit card companies.

Finally, anecdotally, using Peter Lynch-style investing, we see a strong market position for Capital One travel cards in our immediate group. With Citi out of the premium travel card market, Chase and American Express are the dominant players, and Capital One could step in in a big way, especially with its own payments network.

We saw similar performance for T-Mobile a few years ago in our immediate group.

The thesis risk

The biggest risk to our thesis is Capital One going through a massive acquisition with Discover Financial. Massive acquisitions have culture clashes and there is no guarantee that it will be successful. We think it’s a high-potential acquisition, but there are numerous risks that deserve careful consideration.

Conclusion

Capital One has an impressive portfolio of assets, and the company is making a smart decision with its proposed acquisition of Discover Financial. The company has strong cash flow and shareholder returns through both dividends and share repurchases, and quarterly net income is a temporary problem for Walmart.

The company has demonstrated a unique ability to maintain strong net interest rates despite a highly competitive high interest rate market. Overall, we expect the company to be able to generate strong returns for shareholders with future growth potential, making it a valuable investment.