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Instant Analysis: Discover Financial Services Slips on Q4 Earnings

By Eric Volkman - Jan 28, 2016 at 6:16PM

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The company admits it needs to do a better job growing its credit card lending.

What happened?
Shares of Discover Financial Services (DFS -0.97%) slipped in the wake of the company's Q4 results, which fell short of analyst expectations. For the quarter, net revenue amounted to nearly $2.21 billion, a 7.6% improvement over the Q4 2014 result. Net income saw a much bigger jump, by 24% to $500 million ($1.14 per diluted share). In spite of those gains, both top and bottom lines didn't meet the average analyst projections. These had anticipated $2.22 billion in revenue and per-share net profit of $1.30.

During the quarter, total loans rose by 3.5% to over $72 billion. Of that total, credit card lending comprised almost $58 billion.

Discover Financial Services admitted that it could have done better in the latter category. It quoted its CEO David Nelms as saying that "while we achieved record annual originations in both Student Loans and Personal Loans, card loan growth was at the low end of our target range, slower than we'd like."

Does it matter?
Four's a crowd; Discover Financial Services has always struggled to compete against the Big Three, the much larger and prominent brands Visa, MasterCard, and -- its closest competitor in terms of business profile -- American Express .

Like American Express, Discover Financial Services operates what's called a "closed-loop" system, meaning that it not only manages its payment network, it also extends the credit to its cardholders. This is in contrast to "open-loop" companies Visa and MasterCard, which function as network operators (their partners, typically banks, are the entities actually lending the money).

Recently, it's the open loopers that have been scoring important new business. The biggest victory last year was when Visa was chosen to replace American Express as the one credit card brand accepted at popular retailer Costco Wholesale. Recently, Walmart unit Sam's Club also selected Visa as its exclusive credit card method of payment.

Discover Financial Services has certain competitive advantages, such as the scope to charge lower fees than its rivals, but this earnings report shows it's not (yet) leveraging them to its advantage. It doesn't have the power and presence of Visa, MasterCard, or American Express, and thus needs to be scrappier in order to grow at more meaningful rates. Shareholders will not be encouraged by these latest results.

Eric Volkman has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale, MasterCard, and Visa, and recommends American Express. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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