Saturday, February 10, 2007

The long case for Capital One Financial - COF

Capital One Financial – Smart Money Recommendation
As I am reading the March 2007 edition of Smart Money, the magazine interviews David Williams, fund manager of Excelsior Value & Restructuring Fund. His fund has doubled over the last 10 years, as he picks his favorite five stocks for the years ahead. They are:

Anadarko (APC)
Capital One Financial (COF)
Centex (CTX)
Devon Energy (DVN)
MetLife (MET)

As I always look to capture a return on my subscription investment, I decided to research and purchase one of the five stocks recommended by David Williams. My selection is Capital One Financial due to the stability of the equity over the last five years with additional appreciation opportunity.

Company Overview:
Capital One Financial Corporation operates as the holding company for the Capital One Bank, which offers various financial services in the United States and Canada. It accepts demand deposits, money market deposits, NOW accounts, and certificates of deposits, as well as offers consumer loans; commercial loans; automobile and other motor vehicle financing, including financing for the purchase of new and used vehicles, as well as refinancing of existing motor vehicle loans. The bank also offers credit card products, as well as small business lending, installment lending, and health care financing. The company invests in various securities, including the U.S. Treasury and other U.S. government agency obligations, collateralized mortgage obligations, mortgage backed securities, and asset backed securities. The company was founded in 1993 and is headquartered in McLean, Virginia.

5 Year Financial Trends Chart:
For the 5 year period of 2002 to 2006(TTM), COF has achieved a revenue compounded growth rates of 12.0%, with annual growth increasing every year of the 5 years. The net income growth has outpaced revenue with a 5 year growth rate of 28.0% with every year in the double digit rate. Resulting in a consistent improvement in the return on sales metric.

Historical Stock Performance:
If you invested $10,000 on Jan 2nd, 2002 in COF common stock, your portfolio balance would be worth $15,358 or an 7.4% annual return, ~2.0x higher than the S&P 500 of 3.7%. The equity has achieved most of the increase in 2003 and 2004, with a –11% performance for 2006. On a 2007 YTD basis, the equity is up 7% as of February 9th, 2007

Value Scorecard:
A very impressive value scorecard for COF, capturing a passing mark on 6 of the 8 indicators. The strongest of the passing grades is within the free cash flow yield section, coming in at 14.9%. Of the 2 failing marks, there is a slight inconsistency with Free Cash Flow and the update long-term debt to book value has been improving every year.

Sensitivity Chart:
My current valuation model is resulting with the common equity of COF to be valued at a market cap of $39.1 Billion or $95.34 per share.
Here are my assumptions:
- In my sales forecast, I am using the analyst consensus for 2007 & 2008 of $17.1B and $18.7B, respectively. 5% growth thereafter.
- WACC of 8.9%
- Perpetuity Rate of 0%
- Free Cash Flow as a % to Sales of 25% , based on historical averages.
- Cash of $5.6B and total debt of $26.7B from the Q3 2006 filing.

Here is the sensitivity chart on annual sales increase per year vs. the perpetuity rate

Author Disclosue: At the time of post, author does not own any COF shares but has the intention of owning shares in a few days.

Company website
SEC online for 10-K and 10-Q filings Finance website
Smart Money magazine


Jason said...

What'd you think about the Greenpoint closure today? Do you think the share price drop makes it a good time to buy more COF?


I have never been a big fan of banks or financial services stocks.