Credit Card Bargain Hunting


Stock: Capital One Financial Corp. (ticker COF)

Capital One may be of value to possible high teens percentage upside

A recent Barron’s article indicated a 50% upside in Capital One. This blog entry will dissect Capital One’s recent operations and with a layman’s opinion indicate whether the stock is indeed undervalued using traditional and low growth assumptions.

The $38 billion Virginia-based credit services company has performed poorly this year having provided 8.4% total losses to its shareholders compared to Buffett’s recommendation of index investing whereby the S&P 500 provided 13.2% gains.

This performance led to an undervalued 0.8 price to book ratio compared to Capital One’s industry average of 3.8 and a price-earnings ratio of 11.7 times vs. 23.8 times.

Capital One also reported an unappealing 7.7% profit decline in its recent six months of operations on the back of a 6.1% revenue increase to $13.2 billion.

The company’s credit losses provisions rose by 22% to $3.79 billion along with a 5% increase in non-interest expenses, therefore, dampening its profits in the recent first half.

Capital One

According to filings, Capital One Financial Corporation is a Delaware corporation established in 1994 and headquartered in McLean, Virginia.

The company is a diversified financial service holding company with banking and non-banking subsidiaries.

Capital One Financial Corporation and its subsidiaries offer a broad array of financial products and services to consumers, small businesses and commercial clients through branches, the internet, and other distribution channels.

As one of the nation’s ten largest banks based on deposits as of December 31, 2016, Capital One service banking customer accounts through the internet and mobile banking, as well as through cafés, ATMs and branch locations primarily across New York, Louisiana, Texas, Maryland, Virginia, New Jersey and the District of Columbia.

The company also operates the largest online direct banking institution in the United States by deposits. In addition to bank lending, treasury management, and depository services, the company offers credit and debit card products, auto loans and mortgage banking in markets across the United States.

Capital One was the third largest issuer of Visa® and MasterCard® credit cards in the United States based on the outstanding balance of credit card loans as of December 31, 2016.

Capital One has three segments: Credit Card, Consumer Banking, and Commercial Banking

Credit Card: Consists of Capital One’s domestic consumer and small business card lending, and international card lending businesses in Canada and the United Kingdom.

As of June, Credit Card loans represented 41.6% of Capital One’s total loan portfolio.

Revenue in the credit card business grew 6% in the first half to $8.25 billion (63% of gross unadjusted revenue) and delivered income margin of 10% compared to 14% a year earlier.

Consumer Banking: Consists of branch-based lending and deposit gathering activities for consumers and small businesses, national deposit gathering, national auto lending and consumer home loan lending and servicing activities.

As of June, Consumer Banking loans represented 30.7% of Capital One’s total loan portfolio.

Revenue in the consumer business grew 7.7% to $3.47 billion (26% of unadjusted revenue) and margin of 15% compared to 16% a year earlier.

Commercial Banking: Consists of lending, deposit gathering and treasury management services to commercial real estate and commercial and industrial customers. Our commercial and industrial customers typically include companies with annual revenues between $10 million and $1 billion.

As of June, Commercial Banking loans represented 27.7% of Capital One’s total loan portfolio.

Revenue in commercial business grew 9.9% to $1.48 billion (11% of unadjusted revenue) and 24% margin compared to 15% a year earlier.

Selected performance metrics as of first half 2017 (9 items)

Purchase volume

Purchase volume consists of purchase transactions, net of returns, for the period for loans both classified as held for investment and held for sale. Excludes cash advance and balance transfer transactions.

Increased by 7% to $156.3 billion

Net interest margin

Net interest margin is calculated based on annualized net interest income for the period divided by average interest-earning assets for the period.

Increased by 14 basis points to 6.88%

Return on average assets

Declined by 14% to 1.10%

Return on average tangible common equity

Declined by 53% to 11.75%

Efficiency ratio

Efficiency ratio is calculated based on non-interest expense for the period divided by total net revenue for the period.

Declined by 52% to 51.73%

Net charge-offs

Rose 34% to $3.13 billion

Net charge-off rate

Rose 55 basis points to 2.59%

Common equity Tier 1 capital

Rose 60 basis points to 10.7%

Tier 1 capital

Rose by 60 basis points to 12.2%

30+ day delinquency rate

Decreased by 28 basis points to 2.99%

Sales and profits

In the past three years, Capital One had 4.4% average revenue growth, (-)3.38% average decline in profits, and 16.6% profit margin average (Morningstar).

Cash, debt and book value (equity)

As of June, Capital One had $6.72 billion in cash and cash equivalents and $49 billion in long-term debt with debt-equity ratio 1 compared to 1.21 times a year earlier. Overall equity increased by $1.03 billion to $49.14 billion while debt fell by $9.19 billion.

Cash flow

Capital One’s cash flow from operations rose 6.9% to $7 billion in its first half of operations brought mostly by higher provisions for credit losses, proceeds from sales and paydowns, and changes in other assets.

Capital expenditures were $483 million leaving the company with $6.54 billion in free cash flow compared to $6.24 billion a year earlier. Further, dividend and share buyback represented 11% of its free cash flow for the period.

Capital One also allocated $10.5 billion in debt repayments and other activities (net issuances) and raised $79 million in share issuances.

The cash flow summary

In the past three years, Capital One allocated $1.8 billion in capital expenditures, raised $18.7 billion in debt (net repayments and other financing activities), raised $3.75 billion in share issuances, generated $29.5 billion in free cash flow, and provided $10.9 billion in dividends and share repurchases at an average free cash flow payout ratio of 36.5%.


Investors have the right to get afraid of Capital One’s recent hike in loss provisions, but the company’s capital ratios should soothe this concern. Nonetheless, Capital One’s decreasing profitability in recent years should be further observed in the coming quarters.

Capital One remained leveraged despite its impressive debt reduction in recent months. The company also has remained tight grip in its payouts to shareholders in recent years.

Analysts have an average overweight recommendation with a target price of $95.05 per Capital One share vs. $78.7 at the time of writing. Average revenue estimates for this fiscal year multiplied with three-year P/S multiple followed by a 20% margin indicated a per share figure of $85.2.

In summary, Capital One is a buy with $90 target price.


Chairman and Chief Executive Officer (second quarter results)

“We delivered another quarter of resilient growth across our businesses,” said Richard D. Fairbank, Founder.

“We’re investing to grow and transform our company as banking goes digital, we’re driving improving efficiency, and we are building an enduring customer franchise. We continue to be in a strong position to deliver attractive growth and returns, as well as significant capital distribution, subject to regulatory approval.”

Disclosure: I do not have shares in any of the companies mentioned.

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