One of Warren Buffett (Trades, Portfolio)’s largest legacy positions is American Express (AXP, Financial). He has stated his commitment to the business many times since he started buying the stock after the massive salad oil scandal that nearly broke the company.
In the past few years, American Express’ business moat has started to erode as new competitors start to enter the sector, and more payments move online. With the cost of card processing declining with this shift, fewer and fewer merchants are willing to pay American Express’ hefty charges to be part of the network.
The biggest loss American Express suffered last year was that of Costco (COST, Financial), which accounted for roughly 8% of Amex's nearly $1 trillion in billed business in 2015, leaving the company with a roughly $80 billion hole. The company has tried to move on from this saga, but the Costco hole is so big, it will take some time for new income to fill the gap. In the fourth quarter of 2016, both revenue and billed business decreased on a yearly basis, by 4% and 3%. Excluding Costco, and on a constant currency basis, those figures improve to 6% and 7%.
The fightback
American Express looks like it does have the ability to be able to take back some of its lost market share. The company’s fees are not as onerous as some of its rivals. For example, American Express offers two pricing plans for its merchant accounts, a flat fee of $7.95 per month or between 2.89% and 3.20% plus 10 cents per transaction depending on the business type. Paypal and Stripe charge 2.9% plus 30 cents. There are other costs to consider here, and it’s not a pure black-and-white case but for comparison purposes, these numbers make a good point.
Still, over the past week it has emerged that one of American Express' largest skeptics is Buffett’s right-hand man Charlie Munger (Trades, Portfolio).
Last week, Munger spoke at the annual meeting of the Daily Journal Corp. (DJCO, Financial), a company where Munger serves as chairman. On the topic of American Express he commented that he remains “confused” about the company’s future. Munger, as Bloomberg reported, said that looking at the longer-term horizon of companies such as American Express is tough because “if you think you know what’s going to happen to payments systems 10 years out, you are probably under some state of delusion.”
Does this mean that if Buffett had a chance to dump his American Express stake, he would? I doubt it.
Investors are often being warned that past investment performance is no guide to future success, which is correct, but past performance can provide great insight into how a company will perform in the future. Buffett knows American Express inside out, and he knows the company isn’t just going to roll over and let competitors squeeze it out of the market. American Express Ventures is the company’s strategic investment group, which seeks to invest in innovative startups to enhance American Express' presence in consumer commerce and B2B services. One of this venture’s investments is none other than Stripe, so it could be said that American Express isn’t only ahead of the competition; it owns the competition.
American Express has plenty of firepower to take on competitors. The company can lower fees and use credit card income to make up the difference. It can also use its enormous size to acquire peers. But if these two strategic imperatives fail, American Express can always engineer a managed decline, winding down the loan and credit card business to pay down debt and reduce the share count to a nominal amount. Even in this scenario, Buffett would likely see a return on his investment.
The bottom line
Overall, even though Buffett’s right-hand man seems suspicious about the outlook for American Express, the company has what it takes to engineer a fightback. Even if it can’t manage this, the business is likely to continue to generate returns for years to come.
Disclosure: The author owns no stock mentioned.
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