Capital One Has Strategic Pieces in Place

 | Sep 03, 2013 | 1:30 PM EDT
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Since we first recommended Capital One (COF) back on January 14, its shares are up about 5%, lagging the overall market and the S&P Financials, both of which have had gains in the low teens.

Interestingly, the company's operating results have been solid. The most recent quarterly profit report exceeded analysts' expectations, and the follow-up conference call commentary reinforced our conviction as to COF's investment merits.

We view the recent underperformance as a compelling opportunity to invest in an outstanding credit card franchise, and the leading online banking company.

There have been several notable events at Capital One since our original note in January.

First, on the senior management side, the company announced in February that Stephen Crawford, the former chief financial officer at Morgan Stanley, would join the company. Crawford will transition into the CFO role in May, replacing the retiring CFO. He was an advisor to COF while at Centerview Partners.  

Second, the company announced that it was selling its $7 billion Best Buy (BBY) partner credit card portfolio. It also said the board authorized a $1 billion share repurchase program, contingent on the sale's closing, which is expected in the third quarter of 2013.

Third, the company announced that it had received no objection from the Federal Reserve to increase its quarterly dividend to 30 cents a share from 5 cents a share.

Finally, and perhaps most significantly, COF committed to increasing returns to shareholders in the future through a payout ratio (dividends and share repurchases) "well above current industry norms."

The most recent quarterly results exceeded analyst expectations. COF's credit card business showed an improving trend in loan balances. That occurred even as the strategic run-off in balances continues to mask the underlying growth which should be evident next year. Credit metrics remained strong and the net charge-off rate declined from the previous quarter.

COF has spent the past eight years repositioning its business for the future. The ING Direct acquisition last year vaulted the company into the preeminent position in online banking in the United States, complementing its valuable credit card franchise. With all the strategic pieces now in place, COF is poised to show superior earning growth and deliver significantly higher returns for its shareholders.

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