COF: Capital Generation and Digital Opportunity in Payments Can Drive 25% Upside
We expect COF to generate 2015 EPS of $7.70 (20 cents above consensus) as the payout ratio rises to ~80% corresponding to a 2015 buyback amount of $2.5 billion and reducing the average share count by 3-4%; even with this payout ratio, the bank will end 2015 with an equity/assets ratio of 14.8% versus 14.4% today.
- COF has signaled its intent to increase the payout ratio from the current level of just under 30% to “well in excess of” 50% and believes it has this flexibility given its estimate that the Tier 1 common equity ratio (calculated under the Basel 3 advanced approach methodology) is in the range of “low-to-mid” 8% versus the target of 8%.
- At the same time, management has cautioned Fed estimates of capital adequacy under stress scenarios may differ from its own with particular uncertainty arising because it has not yet entered into “parallel run” calculations. It follows the results of this year’s CCAR process, expected to be announced in March 2014, will be an important litmus test.
Along with our expectation that the earnings multiple rises from the current 10x to 12x with more visibility into the potential for margin lift as the yield curve re-normalizes and for growth of the private-label card business as merchants respond to the shift to mobile payments by expanding their proprietary card programs (to enable e-coupons while controlling payments data and to reduce card acceptance costs), our 2015 EPS estimate generates a one-year price target of $92 representing 25% upside from today.
- Even after the sale this September to C of the $6 billion Best Buy card portfolio, COF has a larger private-label card portfolio than ADS and so is #3 behind GE and C (see Exhibit); unlike GE and C, it has a specific focus on using information-based capabilities to design e-coupon programs so as to create marketing advantage for merchant partners.
- We see COF as a natural partner for MCX which will be looking to make credit at point-of-sale available through its mobile wallet and has indicated a preference for working directly with issuers rather than provisioning into the wallet Visa/MasterCard products. Kohl’s, one of Capital One’s major private-label partners, joined MCX this July coincident with MCX’s announcement that it had selected FIS as a transaction-processing partner.