It’s one of the financial giants, an iconic brand known worldwide. So why did American Express Credit Corporation (AXP, Financial) recently find itself on the Guru Bargains list, and is it a bargain today?
2015 has not been kind to Amex. As a CNN Money article put it, “AmEx (AXP, Financial) is the worst performing stock in the Dow this year, and things don't appear to be getting better anytime soon. The credit card giant reported its first quarter results Thursday afternoon. Investors are treating the stock like a cardholder with an overdue balance. Declined!”
The company’s earnings may have done well in the first quarter, but revenue was off, with the company blaming a stronger dollar.
But, investors also have been taken aback this year by Costco’s (COST, Financial) decision to sever its 16-year relationship with AmEx. The co-branded Costco card represents 10% of AXP’s total cards. And, that’s not all: airline JetBlue (JBLU, Financial) also announced it was replacing AmEx with other card providers.
All of this and perhaps more led to this less-than-inspiring chart of the AXP price:
So, can the company find its way back into investors’ favor?
History
1850: The company begins life as an express mail business in Buffalo, New York, by bringing together express companies owned by Henry Wells (Wells & Company), William G. Fargo (Livingston, Fargo & Company), and John Warren Butterfield (Wells, Butterfield & Company).
1852: Two of these principals get together to form Wells Fargo & Company.
1882: Expands into financial services by starting a money order business that competes with the United States Post Office's money orders.
1891: Introduction of American Express Traveler's Cheques.
1958: Launches its first travel charge card.
1965: Incorporated into the current company.
1966: Introduces the Gold Card, its first market segmentation in this business.
1981: Purchases Shearson Loeb Rhoades, the second largest securities firm in the U.S.
1984: Buys Lehman Brothers Kuhn Loeb; to further segment the market, it brings in the Platinum Card.
1987: Brings Optima to market, its first credit card that allows customers to carry a monthly balance.
1993: The company decides to get out of the investment banking business and sells its retail brokerage and asset management business to Primerica.
2008: Wins Federal Reserve System approval to convert to a bank holding company, and become eligible for help under the Troubled Asset Relief Program (TARP).
2009: Repays all TARP obligations taken on the previous year.
2014: Network spending exceeds $1 trillion for the first time.
History based on information at Wikipedia.org
The Business of American Express
We know it as an iconic brand, one of the financial giants of our time, and as a credit card company. In its 10-K for 2014, the company expands on that, “Our principal products and services are charge and credit payment card products and travel-related services offered to consumers and businesses around the world.”
CEO Kenneth Chenault broadens that a bit further again, in the 2014 Annual Report, “I see us as a platform company....We own the world’s largest integrated payments platform— a global network connecting millions of consumers, businesses and merchants.” The CEO is telling us that it’s not just the cards, but all of the infrastructure and data that goes with them. For example, Big Data that can be accessed within all those billions of transactions, and AmEx has access to it.
Technically, it is a bank holding company, and we see that too through the credit card business; sourcing funds at one price and lending them out (credit card balances) at a higher rate.
The company operates through four reporting segments:
- U.S. Card Services: “...issues a wide range of card products and services to consumers and small businesses in the U.S., and provides consumer travel services to Card Members and other consumers.”
- International Card Services: “...issues proprietary consumer and small business cards outside the U.S. and operates coalition loyalty business in various countries.”
- Global Commercial Services: “...offers global corporate payment services to large and mid-sized companies.”
- Global Network & Merchant Services: “...operates a global payments network that processes and settles proprietary and non-proprietary card transactions.”
Among the segments, United States Card Services brings in the most revenue. The biggest source of income overall is what the company calls ‘discount revenue’, fees paid by merchants when card members use their 112 million cards.
Competition
In its 10-K, American Express reports that it operates in a highly competitive industry. It provides this lengthy list of direct and indirect competitors: “...a wide variety of financial payment products, including charge, credit and debit card networks and issuers, paper-based transactions (e.g., cash and checks), bank transfer models (e.g., wire transfers and ACH), as well as evolving alternative payment mechanisms, systems and products, such as aggregators and web-based payment platforms (e.g., PayPal, Square and Amazon), wireless payment technologies (including using mobile telephone networks to carry out transactions), digital currencies, prepaid systems, gift cards and other systems linked to payment cards.”
The biggest competitors, obviously, are the big three, well-known credit card companies. Here’s how Yahoo! Finance sums them up: Visa (V, Financial) with a market cap of $161.36 billion; MasterCard (MA, Financial) with a market cap of $101.06 billion; and Discovery Financial (DFS, Financial) with a $26.64 billion market cap. AXP has a market cap of $79.24 billion.
GuruFocus also lists Triangle Capital Corp (TCAP, Financial), a specialty finance company, as a competitor; it has a market cap of less than $1 billion, making it relatively insignificant competition.
The company itself, in its Investor Day presentation, also segments its competition into traditional and new:
American Express has several advantages that allow it to compete with both traditional and new players. These include its ‘closed-loop’ relationship with card members and merchants; its spend-centric business model; and its brand name.
The ‘closed-loop’ network refers to the fact it recruits both card members and merchants, allowing it to collect data at both ends of transactions. This opens up opportunities for targeted marketing by merchants and special offers to card members. Turning to ‘spend-centric’, the company says spending on its cards is higher than spending on competitors’ cards, thus allowing it to offer richer rewards.
Other
One of the issues that has driven the share price dramatically lower this year is loss of its co-branding project with Costco. AmEx said Costco was driving too hard a bargain, and it could not afford to continue the relationship. It also reports, in its Investor Day presentation, that those co-branded card members are American Express customers. Further, 70% of the spending on those cards took place outside Costco stores.
AmEx is incorporated in New York State and headquartered in New York City.
Unless otherwise noted, information in this section comes from the 10-K for 2014.
Comments: American Express continues to stand as one of the biggest names in the financial industry. It faces larger competitors, but has its brand and niche opportunities that keep it in the game. Revenue comes from four segments, reflecting its international scope and broader penetration into related areas of the financial sector.
Opportunities, Risks, & Growth
Opportunities
Continuing economic expansion in the U.S. and Europe should generate more spending by card members and enrollment of more merchants.
An ongoing shift from cash and checks to plastic cards, including electronically-enhanced cards and smartphone connected cards.
Strong growth of e-commerce and m-commerce (mobile).
Launching a multi-partner loyalty program, Plenti, this spring.
Holders of the new Amex Everyday cards are twice as likely as other cardholders to carry a revolving balance; this generates lending revenue and increases cardholder engagement.
This section based on information in the Investor Day presentation.
Risks
Given the difficulties the company reported earlier this year with foreign exchange, and the market’s reaction to that news, currency fluctuations and foreign exchange controls will be a continuing concern.
Economic conditions can, and will, change for the worse at some point. When they do, American Express has to worry not only about card members, but also about the $4 billion in state and municipal bonds it holds.
The health of financial markets may affect its liquidity, funding needed to make payments to merchants and to meet its other obligations.
Legal issues are an ongoing concern, including a protracted fight with the U.S. Department of Justice over the honor-all-cards provision in merchant contracts.
Capital adequacy rules are becoming increasingly stringent, particularly under the terms of Basel III.
For a full list of risks and potential risks, see the Risk Factors section of the company’s 10-K for 2014.
Growth
Here’s what Amex has brought in (revenue - green line) and what it has distributed to shareholders (EPS - blue line), before dividends, over the past 20 years:
Looking ahead, the company expects EPS to be flat this year, resume growth next year, and get back to strong earnings growth in 2017 and beyond:
Turning to the analysts followed by Yahoo! Finance, they expect AXP to deliver earnings of $5.47 for this year (2015 fiscal, ending on December 31st), just below the $5.56 of 2014. And they expect $5.71 next year (2016).
In the Opportunities section above we touched on a few of the growth areas available to the company; more specific plans can be found in the Investor Day presentation of March 25th.
Comments: Overall, American Express has a strong history of growing its top and bottom lines. And, given its plans and its resources, there’s no reason to believe it will not meet its own target of 12% to 15% EPS growth in 2017 and beyond. At the same time, we can’t help but note from the chart above how hard it was hit by the last two financial downturns.
Management
Chairman and Chief Executive Officer: Kenneth I. Chenault, age 63, has held these positions since 2001. He joined the company in 1981, and was appointed to his first senior executive position in 1993.
Executive Vice President and Chief Financial Officer: Jeffrey C. Campbell, age 53, joined the company and took on these positions in 2013. Previously, he held similar positions at McKesson Corporation.
Board of Directors: 12 board members, including Chairman Chenault; director connections include: health care, government trade policy, entertainment, insurance, pharmaceuticals, technology, education, and media.
ISS Governance QuickScore: 4 - a middling score, on a scale that ranges from 1 (lower governance risk) to 10 (higher governance risk). AXP receives two red flags, for: Boards Practices and Meeting and Voting Related Issues.
Executive and board information sourced at Bloomberg.com
Comments: The CEO and Chairman has an extensive history with the company, and although the CFO is relatively new to American Express, he does have previous experience in the role elsewhere. Along with the rest of the leadership team, they should be able to deliver the results promised to investors.
Ownership
Gurus: 11 of the prominent investors followed by GuruFocus have stock in American Express. Chris Davis (Trades, Portfolio) has the largest holding, at 22,239,723 shares, followed by James Barrow (Trades, Portfolio) with 17,901,396 shares, and Ken Fisher (Trades, Portfolio) with 11,264,810.
Institutional Investors: More than 88% of shares belong to institutional holders, as we see in this chart from nasdaq.com:
Short Interests: Only 1.08% of AXP shares are shorted, a very low level. Historically, short interests spiked to about 4.5% in 2009, but since 2010 have stayed below 2%.
Insiders: GuruFocus puts insiders at less than 1%, but also gives us the following table showing senior officers of the company, led by Chairman and CEO Chenault, have significant holdings.
Comments: A strong ownership profile, with guru and institutional investors holding most of the outstanding shares; management has a big stake as well, while shorts hold relatively few shares.
AXP by the Numbers
| American Express Credit Corporation | Â |
| Number of shares in float | 863,780,000 |
| Number of shares outstanding | 1,020,000,000 |
| Price at close, April 23, 2015 | $78.15 |
| Capitalization | $79,713,000,000 |
| 52 week range | $76.53 to $96.24 |
| Trailing P/E (ttm) | 14.06 |
| Forward P/E (fye December 31, 2016) | 13.69 |
| Price/Book (mrq) | 3.87 |
| Price/Sales (ttm) | 2.48 |
| Return on equity (ttm) | 29.30% |
| Dividend in dollars (forward) | $1.04 |
| Dividend yield | 1.3% |
| Payout ratio | 18.0% |
| Share repurchases in fiscal 2014* | 300,000 |
| Share buyback ratio (fiscal 2014)* | 2.76% |
| Sources: Yahoo! Finance, April 23, 2015, * GuruFocus | Â |
Comments: Shares currently trade at the low end of the 52-week range; Return on Equity (ROE) is strong at nearly 30%; the company pays a modest dividend of just over a dollar a year; and it has been buying back shares.
Financial Strength
The automated system at GuruFocus gives American Express a 4/10 for Financial Strength and 8/10 for Profitability & Growth:
Why the low rating, especially when we see nothing but green icons for that section? Most likely because of the Severe Warning we see just above the Financial Strength section; specifically, the Altman Z-Score is .086, within the danger zone. However, if we read further, we find Altman Z is aimed at industrial, not financial corporations.
Let’s look at the financial issues further, starting with the company’s long-term debt:
As we can see in this five-year chart, while the company carries a significant amount of debt, it has brought the level down. At the same time, we must also remember that AXP must meet Basel III criteria for capital adequacy, so we feel no undue concern about its debt or its fiscal soundness.
Second, let’s review the company’s ability to generate EBITDA (Earnings Before Interest Taxes Depreciation and Amortization).
As this five-year, quarterly chart shows, EBITDA has grown fairly steadily upward, with one very notable exception. Also notable is the backtracking experienced over the past three quarters.
Finally, let’s examine free cash flow, on a quarterly, five-year chart:
Once again a bumpy ride, and for those considering an investment now, the troubling decline in the past few quarters.
Comments: Overall, reasonably strong metrics for long-term debt, EBITDA, and free cash flow. However, many investors will want to see a reversal of the decline in EBITDA and free cash flow for the past three quarters.
Valuation
American Express came to our attention with its recent appearance on the Guru Bargains screener, having seen its price drop at least 10% since a significant Guru purchase. In this case, John Rogers (Trades, Portfolio) bought 1,590 shares at an estimated average price of $89.65 in the fourth quarter of 2014; since mid-February, shares have mostly traded in a range between $77.50 and $82.50.
How should we value AXP? First, we will take a look at the relationship between the share price (green line) and EPS (Earnings Per Share - blue line), since price often follows earnings:
This chart, which takes us to the end of fiscal 2014, shows a fairly close relationship between these two metrics. We get some additional insight by looking at quarterly data on a one-year chart (with a projection to the end of the second quarter of this year):
Based on this chart, we get the impression the market overreacted to the disappointing earnings news and the Costco news earlier this year.
From another perspective, here’s the company’s P/B ratio for the past 20 years. It suggests there’s a possibility the price could go lower before it goes higher again:
Given those perspectives, let’s again review the company’s own ‘guidance’ at the Investor Day conference:
If EPS growth does drop further this year, even modestly, then it’s quite possible the price will continue its decline, stabilize in 2016, and then begin climbing again in 2017.
Comments: The current valuation may be fair, given the state of EPS so far this year, an opinion supported by the history of the P/B ratio and the company’s own forecasts.
Conclusion
I couldn’t argue with anyone who suggested American Express is a good company, with lots of earnings power still to come.
Yet, I would also be reluctant to buy now, since there’s still a considerable amount of downside risk.
The company can offset that to some extent with share buybacks (and it has given itself lots of room to do that). A dividend yield of $1.04 also helps, but won’t be a lot of consolation if the price goes down several dollars.
Yes, this is a bargain and a value stock, but I would prefer to wait if I wanted AXP in my portfolio.
