Capital One Financial: Fundamentals May Not Be Enough

As Wolfe Research analyst Bill Carcache suggested (and Chua KNG reported), the underperformance of financial stocks this year has been caused by concerns about an unexpected increase in spending (mainly as banks had to provision for bad loans), and concerns about an acceleration in credit normalization.

Within the industry, Capital One Financial Corporation (COF) has fared much worse than many of its competitors, as its shares are down 6.5% year-to-date.

This has likely been caused by a quarter-over-quarter deterioration in capital ratios and credit quality measures, such as net write-offs and delinquency rates, as reported in the fourth quarter of 2021 financial results issued on Jan. 25.

I am neutral on this stock.

Capital One’s 2022 Outlook

Based on chairman and CEO Richard D. Fairbank’s upbeat outlook for 2022, which says Capital One will continue to pursue growth opportunities, the stock should therefore be poised for a turnaround in the coming months.

The forecast came before the war in Ukraine, which has significantly worsened the global economic outlook and prompted analysts to lower their estimates of world gross domestic product growth.

On Monday, Fitch lowered projected global GDP growth rates by 0.7 percentage points to 3.5% in 2022, and by 0.2 percentage points to 2.8% in 2023.

In such a scenario, I no longer believe that the Capital One Financial stock rally has as much of a chance of happening, as the headwinds affecting its likelihood seem strong and not short-lived.

Headquartered in McLean, Virginia, Capital One Financial Corporation is a credit services company serving consumers, businesses and small businesses throughout the United States.

Capital One Financial Corporation is on the Fortune 500 list. As of December 31, 2021, Capital One Financial Corporation had total assets of $432.4 billion, of which $311 billion was in deposits.

Fundamentals appear moderately solid as of the fourth quarter of 2022, but this may not be enough to prompt a share price recovery.

Q4 2021

For the fourth quarter of 2021, Capital One Financials’ earnings came in at $5.41 per share, versus the Wall Street consensus of $5.19 per share. Total revenue was $8.12 billion, beating the analyst median forecast of $7.34 billion.

The company reported higher loans across all segments, with the Credit Card segment being the primary driver of overall growth. Average credit card loans were $108.6 billion, up 6% sequentially.

Investment loans grew 6% sequentially to $267.2 billion, consumer loans grew 2% sequentially to $77.4 billion, and auto loans grew 3% sequentially to $75.3 billion. Commercial bank loans also rose 8% sequentially to $81.1 billion.

Increased lending resulted in a 55-basis point year-over-year increase in net interest margin of 6.6% and an increase in tangible book value from $99.60 per common share as of September 30, 2021, to $99.74 per common share as of December 31, 2021.

In addition, the allowance coverage ratio improved (4.12% in Q4 2021 versus 4.43% in Q3 2021), while the criticized non-performing commercial loans remained stable.

Broader Context

The growth in loan demand across all segments has certainly pleased shareholders, as this trend provides a solid basis to expect higher profitability than in the fourth quarter of 2022.

I fear not in such an uncertain global environment, where growth prospects are much lower than before the war in Ukraine.

In addition, six interest rate hikes the U.S. Federal Reserve plans to approve this year to curb rising inflation could lead to stagflation, further lowering expectations. Should stagflation occur, this will be reflected in lower consumer spending, to which Capital One’s operations are heavily exposed.

Analysts expect earnings to fall 25.5% this year and 4.5% in 2023, potentially causing the stock price to trade lower in response.

Wall Street’s Take

Over the past three months, 19 Wall Street analysts have issued a 12-month price target for COF. The company has a Moderate Buy consensus rating based on 14 Buys, five Holds, and zero Sells.

The average Capital One Financial price target is $180.69, implying 34.2% upside potential.

Stock Statistics

Shares are changing hands at $134.44 as of the writing of this article for a market cap of $56.11 billion, a P/E Ratio of 5.1, and a dividend yield of 2.1%.

Conclusion

Despite the latest quarterly report showing significant progress in the business, the stock failed to grow as the market fears the beginning of a stagnation phase that, combined with high inflation, could dampen consumer and small business credit demand.

A negative trend in either of these would accelerate credit normalization and Capital One Financial certainly wouldn’t benefit.

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