We believe the credit card industry is a good place to invest today, and within that industry, Capital One Financial (COF) is among our favorites.
The industry is a resilient one in normal times, and it also managed through the financial crisis in much better fashion than other financial sectors. From structural and timeliness perspectives, the credit card business compares very well with other lending businesses:
- Credit card companies can and do react quickly to changing circumstances, using measures such as credit line adjustments and pricing.
- Credit card loans are based on the customer's credit history and ability to pay rather than on the supposed value of an asset (which created havoc during the housing crisis).
- Credit cards, as a form of payment, are growing relative to cash and checks and are poised to grow further with increased online and mobile transactions.
- Historically, the credit card industry prospers as the economy improves and employment improves, and we expect both in 2013.
- Pricing is expected to remain rational in part because of new regulations and because banking industry participants are still recovering from high loss rates in other parts of their lending operations.
Led by its visionary chairman and CEO Richard Fairbanks, Capital One has evolved from a mono-line credit card company, dependent on securitization as a funding source, into a diversified deposit-taking institution. Fairbank's foresight in acquiring several regional banks prior to the financial crisis (Hibernia in 2005 and North Fork in 2006) was critical to the company's financial stability during the crisis.
Capital One further strengthened its industry position with the opportunistic and strategic purchases in 2012 of ING Direct, a leading online deposit company, and the HSBC credit card portfolio, both of which are expected to be accretive to earnings this year.
The company is very well capitalized and easily passed last year's stress test. We expect similar results for this year's stress test, which should clear the way for Capital One to meaningfully increase its dividend and repurchase shares starting sometime this year. Consensus earnings estimates for Capital One in 2013 are in the $7 range. At the current price of $62, the price-to-earnings multiple on estimated earnings is less than 9x, too low in our opinion.
Given the company's resilient product and strong management team, we envision a price of $75 to $80 per share in the next 12 months. When you ask yourself, "What's in your portfolio?" Capital One could be a very profitable answer.