Don't Say I Didn't Warn You About This Stock
Back in November I listed "5 Companies That I'm Betting Against in 2012" and warned against a potential slowdown in all five companies. Today, just three weeks into 2012, marks the first time I can point and say, "See, I told you so!"
In November I warned that even with housing sentiment coming off of its multi-decade lows, that weakness in that sector would likely translate into weakness in Capital One Financial's (NYS: COF) bottom line. Last night Capital One proved me partially correct.
In spite of loan balances rising 7.9% over the year-ago period, Capital One dismally missed Wall Street's profit expectations. For the fourth quarter, the company posted a profit of $0.88 on $4.1 billion in revenue, a 2.5% decline over Q4 2010. What might seem like another strong quarter looks like a rotten egg next to Wall Street's projections for a profit of $1.52.
The headline EPS missed wasn't the only red-flag, either; expenses at the bank were through the roof. Non-interest income expenses rose unexpected by 25% during the quarter to $2.62 billion. Although many were one-time items, Capital One's management team really didn't offer answer-seeking analysts a good reason during its conference call why expenses rose so dramatically and went on to say that expenses could remain high for quite some time.
Loan-loss reserves also rose during the quarter. Capital One blamed the rise in domestic credit charge-offs on the seasonality of the fourth-quarter and its recent increase in loans undertaken. To some extent, I will give the company some leeway with its increased-loan-balance argument, but it didn't shock me one bit to discover that its home loan business witnessed a 37-basis-point jump in charge-offs and its automotive financing division, despite seeing strong loan growth, also saw a rise in net charge-offs.
Capital One would like you to think that the credit quality of its customers is improving, but I'm seeing the exact opposite. With such an extraordinary amount of its revenue reliant on its credit card division, I don't think it would take much of a swoon in housing to really spike Capital One's loan-loss reserves and put the bank in a bind.
Recent data from homebuilders would suggest that a turnaround may be at hand, but even then I find myself skeptical. Recent reports from Lennar (NYS: LEN) , KB Home (NYS: KBH) , and Toll Brothers (NYS: TOL) showed net order growth of 20%, 38%, and 8%, respectively. Even one of my least favorite indicators, the U.S. Homebuilders Sentiment Index, was propelled to a new four-and-a-half-year high at 25. Still, that all reversed yesterday when data showed that housing starts in December fell 4.1% versus an expected gain of 0.6%. The entire housing sector is nowhere near a bottom yet by my estimation.
This brings me back to my main premise, which is that a decline in the housing sector will cause the credit quality in many of Capital One's consumers to head south in a hurry. Capital One is way too exposed to the credit market for my comfort and I feel we may have seen just the tip of the iceberg in terms of bad news for this bank in 2012, which is why I'm maintaining my CAPScall of underperform on the bank.
What's your take on Capital One's miss? Is the company worth a gamble, or are its ties to the credit market simply too great to ignore? Share your thoughts in the comments section below and consider adding Capital One Financial to your free and personalized Watchlist so you can keep track of the latest news with the company.
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At the time this article was published Fool contributorSean Williamshas no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policythat believes its readers come first.
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