Today's 3 Stock Picks: DFS, MU, TTWO

Shares of Discover Financial Services (DFS) got charged up Thursday after the credit card issuer swung to a profit and said it would seek bank holding status to cut its financing costs.

Fiscal fourth-quarter profit at the company came largely from partial payment of a $2.75 billion legal settlement in an antitrust lawsuit against competitors Visa (V) and MasterCard (MA).

Discover’s credit card sales volume declined from the year-ago quarter, reflecting the challenges facing cash-strapped consumers, while charge offs for bad loans rose from both the previous quarter and last year's period. Other data were also troubling, as both 30- and 90-day delinquencies increased on a sequential and year-ago basis.

In more encouraging news, Discover chief executive David Nelms said the company would apply for bank holding company status in order to qualify for federal bailout funds and to gain access to the Federal Reserve discount window.

Although Discover is in better shape than some rivals, the economic downturn is going to keep pressuring it for some time, analysts said.

“If you think operating metrics were bad in 2008, the worst of the deterioration across all of the companies in our coverage universe is likely to occur in 2009,” Keefe, Bruyette & Woods analyst Sanjay Sakhrani wrote in a sector report Thursday. The analyst said card issuers like Discover, which take on balance sheet risk, will be hit harder than card networks, and acquirers and processors.

SunTrust Robinson Humphrey analyst John Stilmar began coverage of the Riverwoods, Ill., company Dec. 16 with a Neutral rating. Although Discover management has done relatively well reining in risk, growth is needed, and that’s tough to achieve in a recession, the analyst noted.

“With lending and the velocity of spending slowing, the ability to capture greater credit card transaction volume in many respects is predicated on gaining market share” Stilmar wrote. Discover can expand market share either by expanding its lending by attracting new customers or by getting more merchants to accept its cards, the analyst added.

Bottom Line: Buy
Like other financial stocks, Discover’s taken a beating. Buying it now is mostly a bet that it will get government help, but it’s a positive catalyst at a time when such things are scarce.

A big jump in the secondary market for computer memory chips pushed up shares of Micron Technologies (MU) Thursday as investors bet that a floor had been found in falling semiconductor prices.

After months of declines, prices for certain types of memory chips shot up on the electronic marketplace DramExchange recently. That helped boost shares of the Boise, Idaho, company, says Betsy Van Hees, an analyst with Caris & Co.

“I think the move you’re seeing today is about the spot pricing going up,” Van Hees says. “One day doesn’t make a trend, though. The best case would be a flattening-out trend in pricing instead of these constant day in, day out declines. That would be very encouraging.”

Stability in the battered semiconductor market is also being pushed by the government of Taiwan, which is encouraging consolidation in the chip-making industry. The island nation makes about a third of all the chips used in personal computers and other electronics, and its companies have been hit so hard by the recession that the government is considering a financial bailout.

Nanya Technology, which has a licensing agreement with Micron, is considering asking for help, a move that could bolster Micron’s fortunes in the future, says Kevin Vassily, an analyst at Pacific Crest Securities.

“They are forcing the hand of companies in Taiwan to align with stronger players,” Vassily says of the government actions. “Down the road, Micron would be the company that could acquire a company like Nanya, so they’re not only likely to survive, but when the industry gets better, they should be in a position to do fairly well.”

Bottom Line: Hold
There’s still far too much uncertainty roiling the entire chip industry, and as investors in financial stocks have learned the hard way, it’s easy to drown when searching for a bottom.

Take-Two Interactive (TTWO), publisher of the wildly popular video game Grand Theft Auto IV, reported a wider loss for the most recent quarter and said its current-quarter results, which include the important holiday selling period, would be much weaker than expected.

Analysts expected Take-Two to post adjusted earnings of 21 cents a share for the current quarter ending in January, but late Wednesday the New York company forecast a loss of 70 cents to 85 cents a share.

“We cannot predict how long the current economic conditions will last or how significantly they will impact our business over the next 12 months,” said Chief Financial Officer Lainie Goldstein on a conference call. “While we continue to be diligent in working to protect our business in advance with regard to potential bad debt exposure and have had no material impact from any of the retail bankruptcies to date, it may be difficult to completely eliminate that exposure.”

Arvind Bhatia, an analyst at Sterne, Agee & Leach, called the guidance “shockingly below the most bearish expectations,” and said the company was too reliant on the Grant Theft Auto franchise. Although an agreement with GTA game developer Rockstar Games announced Wednesday locks in design talent, Take-Two’s pipeline is weak. Bhatia wrote that this suggests the next iteration of GTA won’t be out until 2011.

Kaufman Brothers analyst Todd Mitchell cut his rating on the stock to Sell from Hold, and said the Rockstar agreement actually weakens an already vulnerable small company.

“It appears that [Rockstar] basically got their old deal (make game, cash big check, repeat), plus a bunch of options, plus the ability to now pursue their own projects independent of Take-Two,” Mitchell wrote. “Without the alignment of [Rockstar] and [Take-Two's] interest with common shareholders, we think Take-Two looks a lot more like a hodge-podge of marginal assets operating with a cost structure that will be difficult to operate with in this environment."

Unlike rivals THQ (THQI), Electronic Arts (ERTS) and Activision (ATVI), Take-Two is not sitting on cash, Mitchell added.

Bottom Line: Sell
You’re better off playing a video game made by Take-Two than holding onto its plunging stock.