I own stock in all three major credit companies, Visa (V), Mastercard (MA), and American Express (AXP). I view all of them as investable businesses for the right price, but unfortunately, these businesses are really only investable when the price is somewhere close to appealing, or at the very least what one might consider fairly valued.
So when I looked at American Express, I figured it was time to solidify my overall stance on the company with a solid article explaining my rationale and explaining the company as a whole. This is especially true because compared to the other major credit card companies, AXP is actually rather underfollowed.
This article aims to do just that – explaining – and show you why I’m willing to pay today’s price for AXP.
American Express – What does the company do?
The American Express company, or Amex, is one of the oldest financial companies in existence and can trace its roots back to its founding back in 1850, over 170 years ago. It’s a member of the Dow Jones, and it’s most well-known for its charge card, credit card, and related businesses, including things like traveler’s checks and the like.
The company is by many, including Forbes, considered to be one of the most valuable brands in the world, and as of 2019, has a market share (in the US) of close to 11.3%. While not as large as competitor Visa and from certain respects could be said to be embattled in terms of market share, it nonetheless holds a very impressive business.
As of FY19, the company had around 114.4M cards in force, with around 54.7M cards in the US alone. The average annual spending on an AMEX was nearly $20,000, and this includes consumer cards, small business and corporate cards from AMEX.
In terms of absolute size, the company is the fourth-largest general purpose card network based on purchase volume, behind China UnionPay, Visa and Mastercard. It’s also the 4th largest in terms of number of cards. The company is also well-established in new payment methods and supports both Google Pay and Apple Pay, and AMEX cards also support NFC payments.
The company gives us three operating segments, which also act as the company’s reportable segments. We have the Global Consumer Services (GCSG), Global Commercial Services (GCS) and Global merchant and Network Services (GMNS), with administrative SG&A and other businesses included in the fourth, “other” segment.
The segments act fairly self-explanatory. The global card-issuing services are run through GCSG and GCS, and the company can be considered most well-known for its cards known as the Green, Gold, and Platinum cards – which are either charge or credit cards depending on customer geography. There are also specialty products, such as the so-called “Black Cards,” where AMEX tries to cater to every possible customer segment. Between its various color cards, it also has co-branded credit cards, usually found in either the Airline, Hotel or Retailer segment.
One of the problems AMEX faces outside of the USA is the limited availability of AMEX acceptance in non-US geographies. As an AMEX cardholder in Sweden, it’s not at all uncommon for me to encounter standard restaurants or even stores – even grocery stores – that don’t accept AMEX. This is actually a bit of an issue when trying to expand things – seeing the extremely widespread acceptance of Visa and Mastercard. The company’s merchant acquiring business clearly has some work to do outside of company standard geographies to get up to par with its competitors.
We need to also mention the company’s quite heavy reliance on the travel and hotel industry, where AMEX has significant exposure, and as a result of COVID-19, some not-insignificant liability.
The company’s payment networks is available in around 94 countries around the world, and the network is maintained by the GMSN segment. As things stand today, it’s easy to see that AMEX indeed needs to push things outside of their home geographies a bit.
(Source: AMEX 2019 10-K)
Unlike some of its competitors, AMEX focuses on a spend-centric business model with primary revenue drivers being spending as opposed to finance charges and fees. The company views this strategy as advantageous, compared to competitors, where AMEX has a higher per-card spend and also offering better value to customers and merchants. This gives AMEX the potential to offer members rewards and benefits, as well as targeted marketing and investments. It is AMEX’s view that this creates an incentive for users to spend more on their cards.
AMEX competitors are fairly clear – as I mentioned before, the four main ones are China UnionPay, Visa, and Mastercard, but there are also smaller ones like Discovery, Diners Club, and others.
In short, AMEX makes its money by facilitating a globally integrated payment system, providing credit and charge cards to consumers and businesses. There are fees, interest charges, merchant charges, and many other ways for a credit card company like AMEX to make its money. Its relatively low credit costs, high discount rates and other company qualities are well-known and make it a popular choice in some investor circles.
This, in a nutshell, is AMEX and what the company does.
American Express – How has the company been doing?
It doesn’t take a crystal ball to understand that when people stop going out to shop – even if they continue shopping at reduced volumes from home – companies like AMEX are pretty much going to suffer some serious deterioration in their business.
In fact, the latest quarters have been some excellent examples just as to how a company like AMEX is impacted by a global pandemic or occurrence which forces people to stay at home to a larger degree. Take a look.
(Source: AMEX 2Q20 Presentation)
While the recovery in billing is ongoing, there is no denying that we’re looking at a significant, double-digit drop in business volumes. Similar to any financial company, AMEX reacted to this by shoring up their liquidity and, in layman’s terms, building floodwalls. While company loans and receivables are down for the first time in many years…
(Source: AMEX 2Q20 Presentation)
… it’s very important to point out that AMEX never during these quarters actually was a loss-making sort of company. And when I’m talking about shoring up liquidity and building floodwalls, we’re of course also talking about loss provisions, again similar to a bank.
(Source: AMEX 2Q20 Presentation)
When we look at things like this, AMEX YoY results start making more sense, and we get more logic behind those numbers. AMEX’s logic for these loss provisions and reserve-building assumptions are a continuing unemployment rate of over 10% going into 4Q20, with a potential GDP contraction of negative 4% in 4Q20.
Revenue growth has taken a leap off a cliff and is now at negative 23% YoY thanks to COVID-19. Before COVID-19, it was at an 11% YoY revenue growth. The fact that card fees are the only item if we look at revenue performance, that’s up, tells its own tale. The company is currently suffering a 2Q20 8% decrease in net interest income, the worst in over a decade, down from a 14% increase in 1Q20.
The tale continues to expenses, which includes items such as cardmember rewards and services, i.e. how people actually use their AMEX cards. Rewards are down nearly 50%, and services are down 63%. While expenses down are good, it’s not good if it’s a direct result of lower member spending.
Now, to the positives.
The company has seen a nearly 300 bps improvement in its CET-1 ratio, as well as a near-doubling of its cash and investment size in less than 3 quarters. As such, the company hasn’t exactly been idle but has made certain to prepare for what they believe may come. Remember, AMEX needs to only have a 6.5% CET-1 ratio to be considered a well-capitalized company – they have more than twice that today. Even during the financial crisis, CET-1 fell to no lower than 9.8%, which gives the company excellent prep for any eventuality.
Recent news items regarding write-offs and delinquencies that have come in during COVID-19 seem to share the overall rebounding and positive nature of the market, however, as the company’s net write-off was up no more than 30 bps YoY, and delinquencies actually fell to 1.4% (10 bps YoY). The company also went ahead and closed its customer pandemic relief program at the end of June.
The fact is, many analysts and writers expected a storm against credit card issuers like AMEX. This is not happening. The expectations from analysts now is, in fact, that reserve builds during 3Q20 may end up quite a bit less than expected.
There are a lot of negative or rather soft sentiments regarding AMEX overall, that I want to qualify with a few facts.
First of all, AMEX has some truly excellent return numbers – I’m not talking”okay,” but excellent ones. AXP averages an easily 20%+ return on equity, which is “up there” in the financial world. Even during the financial crisis, returns on equity have never been negative, and the worst was back in 2017, when the company had “only” a 14% RoE. As it stands now in terms of LTM numbers, the COVID-19 numbers have only come down to 18% – though this may likely trend lower.
Secondly, debt. It’s 0.3X of capital, which is well below many financials as well. It’s not as good as its closest peers, MA and V, but it’s definitely there.
Third, the company has retired nearly 20% of its outstanding shares over a period of 10 years while at the same time delivering rather impressive sales increases.
The point of this section of the article is establishing how the company has done historically – and I believe we’ve done so here, and that performance, prior to COVID-19 and in previously stressful situations, has seen similar positive resurgence once the crisis is over.
Let’s move on to the core of the matter.
American Express – What is the valuation?
For me, it always boils down to what I’m, in the end, willing to pay for a company.
I’ll avoid buying a company not because it’s bad, but because it’s too expensive. I currently consider both peers V and MA to be vastly overvalued, even though I consider them to be excellent companies.
AXP, when viewed at a quick glance, is on the other hand, not overvalued.
(Source: F.A.S.T graphs)
We’re looking at the world’s 4th-largest credit card company trading at a weighted average P/E of 22X – though this is based on 2020E results. There’s no doubt that 2020E results will indeed be poor, but I believe it important to normalize these somewhat, given the rebound that’s expected to happen in 2021 and onward.
If recovering to somewhat normal levels in 2021-2022 and forward, an investment in AXP, based on an expected EPS of $6.94 for 2021 and $9 for 2022 would result in annual gains of 13.60%, based on a 2022E P/E of 15X, which is where the company has traded during better times. AXP, outside COVID-19, has a well-established history of either hitting analyst estimates or beating them handily (more than 10%) after 2009.
Even if we halve the company’s expected growth rate from almost 10% to less than 4% until 2025, a 4% annual EPS growth rate following 2022 would result in annual rates of return of almost 9% until then – again based on a weighted average 15X trading multiple.
I view the $9 EPS in 2022 as perhaps a slightly too bullish number, as I believe traveling challenges may persist well into 2021 and even 2022. However, I view a return to relatively normal business levels of ~$7 EPS for 2021 as fairly valid, given that it’s still a drop from an FY19 $8 EPS which I view as accurately representing some of the company’s challenges regarding its travel and hotel segment. It, again, doesn’t take a crystal ball to realize that until travel & entertainment/lodging sees some fundamental recovery, AXP earnings and numbers will remain challenged. My long-term price target for AXP, therefore, is a lowered 2021-2022 P/E multiple of 15X based on a $6.5-7 EPS, which gives us a share price range of $97.5-$105/share. This includes what I believe to be a fairly realistic expectation for recovery.
Based on these projections, AXP could either be considered slightly overvalued, fairly valued, or extremely slightly undervalued. I view the company as more or less fairly valued at around ~$103/share.
American Express – Bulls and Bears
The bullish thesis hinges on a return to more or less normal operations for AXP. While not tremendously undervalued even with regards to operations during good times – AXP tends to be valued at an earnings multiple around ~15X – the fact is that AXP is undervalued if we consider it likely that the company’s growth trajectory continues in line with historical norms. The fact that you’re able to get a 13-15% potential annual rate of return on a credit card company should be reason enough to make you interested in the company – as we’re usually looking at much smaller potential increases when viewing businesses such as these.
Investors seem to have a tendency to underestimate AXP’s ability to weather the coming storms, and severely underestimate the very real potential of recovery in travel and entertainment. How do you think AXP would do once these segments return to pre-pandemic levels and AXP is trading at a multiple pointing to perhaps 50-70% of the expected EPS of its actual potential? That would include not only annual growth based on yearly EPS growth but a very real potential reversion to a more accurate earnings multiple (based on an EPS of $8-$10 in the medium-term future), as opposed to trading at a 15X multiple based on a much lower earnings number.
The combination of these potentials combined with rock-solid liquidity and safety metrics point to a positive and indeed potentially profitable thesis for American Express.
The bear side has some good arguments too, however.
AMEX’s overreliance on travel, hotel, and similar expenses is a core and excellent one – these segments likely won’t recover 100% into 2021, and this will drag AXP like a millstone. The key question to AXP’s recovery and positive returns over the long term is a return to normalcy for these segments – and bears would argue that no matter how you spin the bull thesis, all of these positive scenarios contain a too-high reliance on a post-pandemic travel/entertainment recovery that may not occur.
If this does fail to occur, the issue could become that earnings continue to see pressure over the coming quarters (and years), which would indicate that the company’s current 2020E P/E ratio of more than 22X isn’t just a fluke – but becomes the trend for 2020 and 2021 – and AXP isn’t worth 22X earnings, which would result in a reversion in the other direction.
The bear argument hinges on the perceived lack of clarity in a post-pandemic reversion, where they would argue that the valuation for the company in fact could be seen as far too high. The stock, at this valuation, should therefore be avoided until it drops to a level that makes more sense using the 2020E EPS as a baseline for how things may look for the next few years.
My thesis obviously agrees more with the bullish view. While I view the bearish view as valid, I look at how things are developing nationally and internationally. With vaccines being developed, no country really in “lockdown” anymore (though distancing measures are in effect), I believe it to be only a question of time until things open up back to normal. In Sweden, things never closed down, and we’re not seeing masks or rising cases anywhere.
Granted, we seem to be in a somewhat unique position with cases trending toward less than 100/day in a few weeks if the moving average continues to move as it has. At the same time, nations like France and Britain are seeing a bit of a “second wave” sort of spike. Still, even in these nations, I consider things to be likely to reverse once vaccines are sorted – and I don’t see this delaying for very long, into 2021. Being that I see a recovery likely in 2021, and I expect traveling to pick up again, I view this as bullish for AXP, and an argument in favor for its ongoing recovery.
That’s not even mentioning that I view the US as likely to recover quicker given its warp-speed vaccine initiative and states wanting to open back up. The US is, after all, the company segment seeing more than 50% of AXP’s revenues as things stand.
Because of this, I view AXP as the only credit card company which, compared to MA’s and V’s P/E valuations of nearly 47X and 40X respectively, can be considered to be in any degree fairly valued or undervalued. Since I want to own stock in all of the three, I view this as a good time to invest more in American Express.
Thank you for your time.
At essentially “fair value” with a target range of ~$97-~$105/share, I view American Express with a “BUY” stance.
Disclosure: I am/we are long AXP, V, MA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.
I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.