COF: Guidance Conservative; Reiterate 2015 EPS of $7.70 and $90 Price Target
We view COF’s guidance for 2014 pre-provision earnings (PPE) of $9.8bn as conservative and reiterate our 2015 EPS estimate of $7.70 (versus consensus of $7.33) and our price target of $90. Consensus appears to discount a flat net interest margin (“NIM”) while we expect rising short rates (with the forward-market indicating 6-month Libor at 1.4% for mid-2015 versus ~0.35% today) to lift the NIM by at least 20 basis points; each 10 basis point increase in NIM lifts EPS by ~35 cents.
Regardless, COF is mispriced. Even 2015 consensus estimates represent a 16% return on current tangible book value (“TBV”) of $46.2/share which is consistent in our valuation framework with a TBV multiple of 1.7x (see Exhibit). Given we do not expect a falling return, we apply this to end-2014 TBV/share of $50 for a valuation of $85 representing 20% upside from today’s close.
-CEO remarks that NPV-at-origination is as good as it has been for a long time bode well for forward earnings power (and explain the increased guidance for marketing spend).
A risk to the thesis is that capital is trapped by the CCAR process in which case returns will decline. COF appears over-capitalized already by $6bn (CET1 ratio of 10.9% under Basel 3 versus the expected target of 8% on ~$225bn of risk-weighted assets) but there is uncertainty: COF will transition to the “advanced” approach (versus the above numbers under the “standard” approach) and, in any event, the Fed has discretion based on its stress-test analysis.
-Our model assumes the total payout ratio, across dividends and buyback, rises to 70% in 2014 and 90% in 2015 versus 25% in 2013; even so, COF is de-levering on an accounting basis (given our assumption of a flat balance sheet over the next two years).
Strategically, COF is well-positioned, given its private-label card business and data-analytics capabilities, to support merchants as they look to take advantage of mobile payments to integrate payments with marketing through personalized and targeted e-coupon businesses. We see the potential for COF to replicate the funded portion of ADS’ business model and to become a key.