Business Strategy and Outlook:

United Airlines is the most internationally focused U.S.-based carrier by operating revenue, with almost 40% of 2019 revenue coming from international activities. Before the COVID-19 pandemic, much of the company’s story focused on realizing cost efficiencies to expand margins. It is anticipated that United’s international routes will not be as pressured, but that international flights will be difficult to fill until a COVID-19 vaccine is developed and distributed. A recovery in business travel is believed to be critical for United to maintain the attractive economics of the frequent flier program. Business travellers will often use miles from a cobranded credit card to upgrade flights when their company is unwilling to pay a premium price. Banks are willing to pay top dollar for these frequent flier miles, which provides a high-margin income stream to United.

The COVID-19 pandemic has presented airlines with the sharpest demand shock in history, and most of our projections are based on our assumptions around how illness and vaccinations affect society. A full recovery in capacity and an 80%-90% recovery in business travel is expected that subsequently grows at GDP levels over the medium term.

Financial Strength:

United has a roughly average debt burden relative to peer U.S. carriers, but an average airline balance sheet is not strong in absolute terms. United carries a large amount of debt, comparatively thin margins, and substantial revenue uncertainty. As the pandemic has wreaked havoc on air travel demand and airlines’ business models, liquidity has become more important than in recent years. The primary risks to airline investors are increased leverage and equity dilution as airlines look to bolster solvency while demand is in the doldrums.

United’s priority after the pandemic will be deleveraging the balance sheet, but it is expected that this will take several years due to the firm’s thin margins. United came into the pandemic with a reasonable amount of debt, with the gross debt/EBITDA ratio sitting at roughly 4.5 times in 2019. United, like all airlines, has materially increased its leverage since February 2020 and has issued debt and received support from the government to survive a previously unfathomable decline in air traffic. As of the fourth quarter of 2021, United has $33.4 billion of debt and $18.3 billion of cash on the balance sheet.

Bulls Say:

• United has renewed its frequent flier partnership with Chase, potentially creating room for long-term margin expansion. 
• An increasing focus on capacity restraint across the industry, combined with structurally lower fuel prices, should boost airlines’ financial performance over the medium term. 
• Leisure travellers have more comfortable with flying during the COVID-19 pandemic.

Company Profile:

United Airlines is a major U.S. network carrier. United’s hubs include San Francisco, Chicago, Houston, Denver, Los Angeles, New York/Newark, and Washington, D.C. United operates a hub-and-spoke system that is more focused on international travel than legacy peers.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Business Strategy and Outlook

Despite initial fears, Discover came through the COVID-19 pandemic with few issues. Its credit card portfolio–its largest source of income–shrank 7% in 2020, a year when most credit card issuers saw declines in the double digits. Perhaps more surprisingly, net charge-offs fell in 2020 and have remained well below normal levels since, both in absolute terms and as a percentage of total loans. We anticipate credit costs will be higher in 2022 but given how low the firm’s delinquency rates are we do not expect a full return to normal credit costs until 2023. We don’t expect this to put any pressure on the bank’s balance sheet as Discover is in a strong financial position to withstand higher credit losses. 

Discover generates most of its revenue through interest income from its credit cards (roughly 70% of its net revenue). While the company has strong positions in the private student debt and personal loan markets in addition to operating its own payment network, its long-term health will be driven by its ability to build and sustain its portfolio of credit card receivables. Discover’s credit card business has been performing very well in recent years, with receivable growth and credit results better than most of its peers. With the majority of its credit cards and student loans charging variable interest rates, the bank will also be a beneficiary of rising interest rates, though this is limited by the firm’s reliance on online deposits. 

In the long run, Discover must continue to deal with the challenges that come with being smaller than many of its competitors in size and scope. Many of the traditional banks that the company competes with can offer their cardholders a broader selection of products and services. Discover’s more traditional competitors often benefit from a lower cost of funding driven by their strong deposit bases. While it is unlikely that Discover will ever fully replicate the product offerings of some its peers, it has made good progress in improving its funding cost through the use of online savings accounts. We are encouraged by its initial forays into checking accounts, as this should help Discover further narrow the cost of funding gap

Financial Strength

Efforts to conserve capital by suspending share buybacks in the initial stages of the pandemic paid off and the company was able to navigate the uncertainty of 2020 and 2021 with ease. Despite increasing shareholder returns in the second half of the year, Discover came out of 2021 in a strong financial position, ending the year with a common equity Tier 1 capital ratio of ratio of 14.8%. We expect the firm to continue its share repurchases in 2022 as Discover works to move back toward its target Tier 1 ratio of 10.5%. In our view, this is an adequate reserve ratio, given that historically the firm has had strong underwriting standards with credit card net charge-off rates below its peers.

 The firm has had success in improving its funding, with more than 70% of total funding now coming from deposits. On the other hand, Discover primarily relies on online savings accounts and brokered deposits. This means it must compete on price for accounts, giving it a higher cost of funding than many of its peers. The company is seeking to mitigate this with an expansion into online checking, but these efforts are still in their early stages.

Bulls Say’s

• Discover has consistently been able to generate returns on equity that are among the highest of its peers. 
• Discover’s credit card receivables growth has been above the industry average for some time now. This outperformance continued in 2020 when its receivables balance shrank less than its peers’. 
• Discover has made good progress in improving its deposit base through online savings accounts and more recently online checking.

Company Profile 

Discover Financial Services is a bank operating in two distinct segments: direct banking and payment services. The company issues credit and debit cards and provides other consumer banking products including deposit accounts, students loans, and other personal loans. It also operates the Discover, Pulse, and Diners Club networks. The Discover network is the fourth-largest payment network in the United States as ranked by overall purchase volume, and Pulse is one of the largest ATM networks in the country.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.