Inside the Capital One Conference

 | May 28, 2014 | 9:30 AM EDT
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It's conference season in New York and one presentation that I attended was Capital One (COF). I've admired the turnaround that management has overseen since the financial crisis and I was impressed with the commentary. We own and like several financials in Action Alerts PLUS, including Bank of America (BAC), JPMorgan Chase (JPM), SunTrust (STI), U.S. Bancorp (USB) and Hartford Financial (HIG). And we've been eyeing American Express (AXP) for a few weeks but it's moved away from us, unfortunately. But another one I am watching is COF; if there is a pullback, it's worth owning.

Today, we saw another round of encouraging data: Durable Goods rose 0.8%, Core Capital Goods Shipments were revised higher in March at 2.1% (this measures business investment), the 20-city S&P/Case-Shiller Housing Index posted a 12.4% increase to home prices over last year, and FHFA house prices improved 6.5% nationally. All of the figures beat consensus and were encouraging incremental news after the spate of softer data in the weather-impacted first quarter.

On the flip side, inventories were adjusted downward and it now looks like first-quarter GDP will be down 0.5% to 1%. But the catch-up trends look to be strong and second-quarter expectations are now at 3% to 4%. Again, some of it is pent-up demand from weather, but I believe we are at an underlying trend at 2% to 2.5% GDP that should see an acceleration into the end of the year. I like the industrials and financials given that they've lagged the broader average to date and have the most leverage in this environment. A stronger economy will put an upward bias on bond yields, produce stronger loan growth and better profitability (as measured by net interest margins).

Over the last 10 years, COF has acquired 16 companies valued collectively at $32.3 billion. The largest three were North Fork for $14.6 billion purchased in 2006; ING Bank for $9.1 billion in 2011; and Hibernia for $4.9 billion in 2005. The strategy has been to diversify beyond credit cards and into consumer and commercial financial services offerings. It's gone from being a monoline credit card company into one with a broad array of products and services, which has in turn led to more consistent earnings and a stronger balance sheet. It has built national size and scale in both traditional and online banking while supporting its higher-returning credit-card portfolio. Credit cards currently drives the bulk of the revenues at 62% but the growth catalysts will be come from the expansion into the community and commercial bank, driven by the recovery in its national auto lending segment and localized commercial banking.

Fast forward to the presentation, where trends appear to be improving in its portfolio. April average U.S. Card balances improved 1% over the prior month, or 12% annualized, to $68.5 billion. On a year-over-year basis, April average balances fell 2% and in line with second-quarter consensus. Given that seasonality usually picks up throughout the second quarter, these numbers likely have a bias upward. Management expects to see domestic growth in the second half of the year driven by new account originations, increased lines for existing customers, auto, commercial (although not at the 18% growth it just posted in the first quarter) offset by slower mortgage (it reiterated it will see $5 billion in mortgage run off in 2014). Credit card losses improved 20 basis points to 3.98% and delinquencies fell 20 bps to 2.82%. International Card losses were the partial offset, and I'd argue the area where the company has opportunity to see improvement in 2015. Card losses in this segment fell 44 bps to 4.25% but delinquencies improved 11 bps. Average Auto receivables expanded in April at an annualized 21.8% monthly rate and 18.4% higher on an annual basis. April U.S. Card loss rate dropped in the month to 3.98% (down 19 bps) and the monthly delinquency rate dropped 20 bps to 2.82% -- the lowest in 10 years. Auto Net Charge Offs fell to 1.01%, the best since May 2012.

There was enough in the presentation to make me notice that trends are gradually recovering, led by domestic card and auto, and that international card is likely the 2015 story as global economies show improvement.

Shares trade at a reasonable 1.6x tangible book value vs. its 1.8x 10-year average, and at 10.8x earnings vs. the 10-year at 12.4x. So it's on my watch list to buy on a pullback. I like the internal moves the company has made to drive growth into adjacent areas beyond credit cards, the leverage it has to a better U.S. economy, and the capital distribution to shareholders.



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