Two financials that receive around a "buy" rating on the Street, but have considerable risk are Capital One (COF) and American Express (AXP). While the former has upside from alleviated concerns about the effects of regulations, the latter has shown strong execution and catalysts. Even still, I believe that uncertainty in loan growth and consumer activity will hold back shareholder value (see here for why).
From a multiples perspective, Capital One is cheaper than Amex. It trades at a respective 5.6x and 7.2x past and forward earnings, while Amex trades at a respective 11.9x and 11.3x past and forward earnings. Both firms have betas around 1.8, which means high volatility. As the economy picks up, I anticipate investors shifting to financials with greater scale and maturity.
On the third quarter earnings call, Capital One's CEO, Rich Fairbank, noted modest performance amidst a challenging regulatory environment and economy:
"Domestic Card loan balances declined modestly in the quarter, but excluding the installment loan runoff, revolving Credit Card loans grew by just under $300 million in the quarter, up about 0.5% sequentially and up about 4.5% compared with the third quarter of 2010. We expect seasonal growth in Domestic Card loan balances in the fourth quarter.
Beyond loan growth, there are continuing signs of traction in our Domestic Card business. New account originations continue to grow, and new accounts booked in the third quarter of 2011 were more than double the new accounts booked in the third quarter a year ago. Growth in purchase volume continues to outpace the industry. Our purchase volume grew 17% from the third quarter of 2010, excluding the impact of the Kohl's portfolio".
Loan balances were up by a fair amount in Consumer Banking largely due to a 17% sequential growth in auto loans exceeding shortcomings in Mortgage Portfolio. Commercial Banking continued to do well with ending loans up 3% sequentially, but particularly noteworthy was the strong growth in C&I and CRE. Accordingly, management believes that loans are rising from a trough.
Delinquencies rose for the fifth consecutive month in October while card losses also rose. Although this was expected as a seasonal trend, 2011 results are likely to be an inflection point for the firm as investors judge the company by how it competes against certain stresses. In regards to the CARD Act, however, management has shown that Capital One can weather the negative regulatory environment. Even still, I anticipate ROE to decline by around 100 basis points to 10% in 2013.
Consensus estimates for Capital One's EPS are that it will grow by 26% to $7.57 in 2011, decline by 19.7% in 2012, and then grow by 12.5% in 2013. Assuming a multiple of 8.5x and a conservative 2012 EPS of $5.94, the stock has 16.4% upside - not enough, in my view, to consider calling it a value play. If the multiple were to hold steady at 5.6x and 2012 EPS turns out to be 11.2% below the consensus at $5.40, the stock would fall by 30.3%.
Amex has slightly greater upside, but the downside is still considerable. During the third quarter, average loans grew y-o-y for the second consecutive quarter and strong billings with flat interest income led to healthy top-line improvement. Moreover, improving credit trends place the company in a favorable position to drive returns and grow margins. With that said, I am slightly concerned about capital allocation as management seems hesitant given the Fed's policy.
Consensus estimates for Amex's EPS are that it will grow by 21.5% to $4.07 and then by 2% and 11.1% more in the following two years. If the multiple were to decline to 8x and 2012 EPS turns out to be just 2.1% below the consensus at $4.06, the stock fall by 30.7%. Thus, although the Street currently rates shares a "buy", I rate them more of a "hold".
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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