Back on January 17th Capital One Financial (COF) missed the consensus estimate from their Q4 earnings report and lowered their revenue guidance for FY 2013. Consequently, the stock has shed 18% thus far. As the market oscillates near its historic highs, this does not at first blush seem to make for a compelling buy. Financials in aggregate are up 8.5% YTD while COF, the 6th largest bank in the US, is down -12.3%.
Yet the recent selloff has also made COF one of the most undervalued names in the sector. With a book value per share (BVPS) of $68.10, the current price puts the stock at a mere 0.75x and only 7.5x the 2014 consensus estimate of $6.76, all while maintaining a return on equity of 10.64%. These cut-rate multiples are the kind of numbers that get value investors salivating. But the severe selling in the wake of the earnings report, going on 5 weeks now, is indicative of a fundamental shift in attitude towards the company. So what is the long term outlook for COF? After a run of 7 straight positive weeks, the S&P posted its first negative week from Feb 18 – 22. If the market pulls back from here, will COF’s bargain valuation provide downside protection? Or if the market surges to new highs, will COF continue to underperform its peers?
Linked to an Improving Economy
COF has positioned itself to benefit from a turnaround in consumer deleveraging, increased loan growth, and more robust consumer spending in 2013. In other words, if economic growth returns in earnest in 2013, COF could possibly outpace other financial stocks given its current position in the back of the pack. Card delinquencies hit an 18 year low in Q3 of last year, indicating a trend by consumers to cut back on discretionary spending, clean up their credit records, and repair personal balance sheets in light of a sluggish economy. While lower delinquencies means fewer charge offs and less bad debt for banks, it also means lower interest income from revolving credit. COF has hinged its FY 2013 performance to take advantage from a marked upswing in credit use and a return to good old American “buy today, pay tomorrow” consumer leveraging.
Continued low rates will certainly help their cause. If credit costs begin to rise, however, COF could see tough sledding through the year. Upticks in loan growth, consumer confidence, and consumer spending without commensurate upticks in rates will be made-to-order for COF. On the other hand, the company is hoping that Walmart’s (WMT) report from its most recent quarter is not indicative of things to come through the rest of 2013. With 82% of its total loan portfolio in consumer loans (and 40% in domestic credit card receivables) and only 18% in commercial (nearly half in real estate), it is evident why so much centers on the strength of the American consumer.
Effects of Acquisitions
COF recently acquired ING Direct and HSBC’s US credit card portfolio. The former ING Direct and Sharebuilder sites were recently rebranded at the beginning of February. Additionally, COF announced that it is selling its portfolio of Best Buy retail credit cards to Citigroup, worth approximately $7 billion. While COF management expects this sale to be earnings neutral, the acquisitions of ING Direct and HSBC cards should give COF more expense flexibility and growth potential once the acquisitions are completed. However, HSBC’s card portfolio contains higher charge-off rates since HSBC had less stringent credit terms than COF. So while the overall credit card portfolio will get a significant boost and see cost synergies, the increased overall charge off rate necessitated that COF set aside an additional $1.15 billion in provisions to cover loan losses – part of the reason for COF’s disappointing earnings announcement.
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Increasing Total Payout Ratio for 2013
COF is not a high yielding stock: it currently has a dividend of only $0.20, or 0.4%. However, management reiterated in its earnings report that in spite of tempered revenue expectations for FY 2013 it still expected to raise its dividend “meaningfully”. Analysts are looking for an increase to $0.40 per share, double the current level. Additionally, analysts believe the company will begin to buy back shares towards the latter part of 2013 due to high capital accretion. A share repurchase program would bring COF’s total payout ratio to 16% for 2013 and 53% in 2014.
The Price Action
An increasing dividend totaling a 0.80% yield will most likely not be sufficient weight to balance the scales of rising provisions for loan losses, lower loan growth, high acquisition costs, or, most importantly, a fundamental shift in price action.
The chart below shows the break in the 16 month long uptrending channel that followed the January 17th earnings report. Following a meager attempt to retrace back to the trendline, the stock fell further to break through the $55 support level. These two consecutive breaches of technical support indicate a reversal of COF’s long term trend – as well as a reversal of investor psychology towards the stock.
COF 2 year
Chart Courtesy of MetaStock Professional
However, this reversal has occurred so quickly, taking out over $6 billion in market cap and turning a solid value stock into an outright bargain that the stock is primed for a sharp move back up.
In the 1 year chart below, the MACD and Stochastics have fallen to or near their current levels only twice and both times were followed by decisive rebounds. COF tends to see a lot of whipsaw action as it is, often retracing moves abruptly to return to a mean trendline. Given these characteristics, it is likely that COF will rebound, possibly back to the $55 level which is now resistance.
COF 1 year
Chart Courtesy of MetaStock Professional
For a short term trade, COF could provide $2-5 of immediate upside. As of the Feb 26 close, the Mar 52.50 calls are $0.66 while the 55s are $0.17. Both could see significant appreciation if the stock rebounds quickly although they only allow for 13 more trading days before expiration.
From a long term perspective, COF will definitely appeal to value investors at this price. However, it may take some patience and dedication. The recent price action points to a definitive change in investor sentiment and outlook and it may take some time before COF recovers the confidence that the last earnings report has obviously lost.
- The Ticker: COF
- The Trade: Buy at $51
- Trade Opened: February 28, 2013
Chart courtesy Finviz. Click to open in larger window.
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