American Express AXP
April 01, 2007 - 4:49pm EST by
danarb860
2007 2008
Price: 56.40 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 67,000 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

I wrote up American Express roughly 2 years ago.  The company has long since completed its spin-off of Ameriprise, and I believe continues to be a fantastic investment.  The stock has done well since the spin-off; but it is recently down 10% to a level which I think provides a nice short-term entry opportunity. 

 

In 2006, the company earned just over $3.00.  Earnings are expecting to be roughly $3.40 in 2007 and $3.80 in 2008.  So the stock is trading at 16.6x this years earnings but under 15x next year.  This multiple seems to be too low for a company with solid double--digit earnings growth and ROE of nearly 35%.  The ROE exceeds the 33% that was forecasted previous to the spin-off. 

 

The company has a lending portfolio that is roughly $50bn.  But this compares with an equity market-capitalization of about $67bn.  In this respect, thinking about American Express as a traditional credit-card issuer is not appropriate.  In fact, the company could easily take on more debt if it wanted to do major buy-backs  (more on buy-backs below).  An interesting company to look at as a comparison is MasterCard, which just came public.  With ROE of in the mid-twenties, Mastercard is showing closer to 20% EPS growth.  I think however, that much of this growth is coming from plucking low-hanging fruit as I suspect that the company, formerly coop owned by a number of major banks, may now be profit-focused for the first-time in the after-math of coming public.  In this respect, it is worth noting that 2006 transaction growth for MasterCard was slightly below American Express’s.

 

Compared to any other player, American Express has what I believe to be a dominant position because it controls all aspects of a payment.  It touches the paying customer; it is the card issuer; it has the relationship with the vendor; and it processes the transaction.  Nobody touches this many pieces of the transactions.  All companies operating with any critical mass in the space have relatively high ROE’s.  In AXP’s case, touching all pieces creates an efficiency that leads to highly favorable returns.  Additionally, the efficiency of the network, combined with the brand as well as the network effects from touching all pieces of the transaction allows AXP to charge a discount rate that is over 1% higher on average than MasterCard and Visa.  In fact in 2006, the discount rate at 2.55% was unchanged from 2005.  That it is not going down is quite bullish for the company.

 

Also in 2006 vs. 2005, card billed business was up 13%.  Cards in force increased from 43mm to 48.1mm in the US and from 28mm to 29.9mm abroad.  Basic cards in force increased from 56mm to 62.5mm.  Observers of the company tend to see the key metrics as the discount rate, card billed business, and basic cards in force.  Each of these three showed nice growth during the year, and this growth reflects a business that I believe is extremely strong.  It isn’t a perfect proxy but comparing marketing, promotion, rewards, and cardmember services to Discount Revenue and Net card fees provides a useful indicator of the business’s health over time.  It isn’t a perfect proxy as if the company is investing in the business to show growth, margins can decline and the business can throw off additional cash if the company under-invests.  In 2005, these two categories grew a combined 10.72% while the cost categories grew 11.55%.  While I do not like this gap and intend to track it carefully going forward, I will point out that discount revenue was up 13% while net card fees were down 2%.  I believe this trend reflects that more of the membership growth is coming from partners as opposed to coming directly.  Most important to note however, as the leverage is in the card-spend is that card spend is up quite a bit more than the cost categories.  

 

In short, AXP continues in my view to be a superb company.  It has tremendous franchise value and it continues to trade at what I view the multiple of an average company.  As I mentioned two years ago, the business feels like a fantastic inflation hedge; if prices go up, its earnings power will go up.  There are fewer and fewer companies that I believe this can still be said about.  So I see both appreciation from earnings growth and revaluation as likely.  18x next year’s projected $3.80 leads to a $68 stock.  The $.60 annual dividend yield isn’t going to add much to the returns. 

 

AXP is underlevered.  It has $11bn of equity against $66bn equity market cap and $50bn of loans.  It has 58bn of long-term and short-term debt.  Consequently, there is ample room to put leverage on this company.  And compared to two years ago, given the size of the deals in the private equity and banking sectors, it is hard to believe that I am going to write these words, but AXP is buyable. 

 

 

 

 

 

Catalyst

Continued high ROE, powerful franchise leading to earnings growth, possible expansion of multiple, buybacks
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    Description

    I wrote up American Express roughly 2 years ago.  The company has long since completed its spin-off of Ameriprise, and I believe continues to be a fantastic investment.  The stock has done well since the spin-off; but it is recently down 10% to a level which I think provides a nice short-term entry opportunity. 

     

    In 2006, the company earned just over $3.00.  Earnings are expecting to be roughly $3.40 in 2007 and $3.80 in 2008.  So the stock is trading at 16.6x this years earnings but under 15x next year.  This multiple seems to be too low for a company with solid double--digit earnings growth and ROE of nearly 35%.  The ROE exceeds the 33% that was forecasted previous to the spin-off. 

     

    The company has a lending portfolio that is roughly $50bn.  But this compares with an equity market-capitalization of about $67bn.  In this respect, thinking about American Express as a traditional credit-card issuer is not appropriate.  In fact, the company could easily take on more debt if it wanted to do major buy-backs  (more on buy-backs below).  An interesting company to look at as a comparison is MasterCard, which just came public.  With ROE of in the mid-twenties, Mastercard is showing closer to 20% EPS growth.  I think however, that much of this growth is coming from plucking low-hanging fruit as I suspect that the company, formerly coop owned by a number of major banks, may now be profit-focused for the first-time in the after-math of coming public.  In this respect, it is worth noting that 2006 transaction growth for MasterCard was slightly below American Express’s.

     

    Compared to any other player, American Express has what I believe to be a dominant position because it controls all aspects of a payment.  It touches the paying customer; it is the card issuer; it has the relationship with the vendor; and it processes the transaction.  Nobody touches this many pieces of the transactions.  All companies operating with any critical mass in the space have relatively high ROE’s.  In AXP’s case, touching all pieces creates an efficiency that leads to highly favorable returns.  Additionally, the efficiency of the network, combined with the brand as well as the network effects from touching all pieces of the transaction allows AXP to charge a discount rate that is over 1% higher on average than MasterCard and Visa.  In fact in 2006, the discount rate at 2.55% was unchanged from 2005.  That it is not going down is quite bullish for the company.

     

    Also in 2006 vs. 2005, card billed business was up 13%.  Cards in force increased from 43mm to 48.1mm in the US and from 28mm to 29.9mm abroad.  Basic cards in force increased from 56mm to 62.5mm.  Observers of the company tend to see the key metrics as the discount rate, card billed business, and basic cards in force.  Each of these three showed nice growth during the year, and this growth reflects a business that I believe is extremely strong.  It isn’t a perfect proxy but comparing marketing, promotion, rewards, and cardmember services to Discount Revenue and Net card fees provides a useful indicator of the business’s health over time.  It isn’t a perfect proxy as if the company is investing in the business to show growth, margins can decline and the business can throw off additional cash if the company under-invests.  In 2005, these two categories grew a combined 10.72% while the cost categories grew 11.55%.  While I do not like this gap and intend to track it carefully going forward, I will point out that discount revenue was up 13% while net card fees were down 2%.  I believe this trend reflects that more of the membership growth is coming from partners as opposed to coming directly.  Most important to note however, as the leverage is in the card-spend is that card spend is up quite a bit more than the cost categories.  

     

    In short, AXP continues in my view to be a superb company.  It has tremendous franchise value and it continues to trade at what I view the multiple of an average company.  As I mentioned two years ago, the business feels like a fantastic inflation hedge; if prices go up, its earnings power will go up.  There are fewer and fewer companies that I believe this can still be said about.  So I see both appreciation from earnings growth and revaluation as likely.  18x next year’s projected $3.80 leads to a $68 stock.  The $.60 annual dividend yield isn’t going to add much to the returns. 

     

    AXP is underlevered.  It has $11bn of equity against $66bn equity market cap and $50bn of loans.  It has 58bn of long-term and short-term debt.  Consequently, there is ample room to put leverage on this company.  And compared to two years ago, given the size of the deals in the private equity and banking sectors, it is hard to believe that I am going to write these words, but AXP is buyable. 

     

     

     

     

     

    Catalyst

    Continued high ROE, powerful franchise leading to earnings growth, possible expansion of multiple, buybacks

    Messages


    Subjectyou think C or BAC or JPM
    Entry04/01/2007 08:49 PM
    Membergb48
    or other big money centers could potentially try to acquire AXP? would make sense..

    Subjectyes
    Entry04/01/2007 09:26 PM
    Memberdanarb860
    Yes I do. Interesting that C's new CFO is from AXP. AXP has wonderful worldwide brand cache, and it simply isn't as untakeable as one might once have thought. Members spend on avg. $7,000+ per year. Some interesting anti-trust issues however, but the industrial logic is certainly sound.

    Subjectappreciation potential
    Entry04/02/2007 08:27 AM
    Memberrobert511
    So you see the appreciation potential as approx 21% (68/56)? It's hard for me to get excited about a Fair Value estimate that relies on a PE=18. What am I missing?

    Subjectfair value
    Entry04/02/2007 08:45 AM
    Memberdanarb860
    If you want to stay without a multiple increase, then I think the yearly appreciation potential is in the low double digits. Margin expansion can be cosidered as gravy. But what do you consider the right multiple for a company with this financial profile. Your questions suggests that whether the stock trades at 65, 60, 55, 50 etc. today, it is the right price.

    Subjectvaluation on fee vs. lending s
    Entry04/02/2007 01:59 PM
    Memberzeke375
    I'm wondering if anyone here can help me out in how to think about valuing AXP's different segments. It seems like AXP combines a capital-unintensive fee business with a capital-intensive lending business. Unfortunately AXP doesn't break out its financials in a way that facilitates this type of analysis (at least not that I can tell). If I had the respective income/assets of each segment, I would envision putting a high multiple on the fee segment income, and then apply a low multiple on the lending segment income. Has anyone looked at AXP from this type of perspective?

    Subjectbacking into it
    Entry04/02/2007 09:32 PM
    Memberdanarb860
    as a proxy for it, carmember lending finance revenue, net of interest less cardmember lending/provision for losses is roughly 37% of profits. So what you would describe as the low-value piece is roughly this levels of profits, and I think this would be a conservative number.

    Also, previous company documents breaks out the segments in some detail. TRS (Travel Related Services) was roughly 80% of profits.

    SubjectBacking into it-Question
    Entry04/02/2007 10:19 PM
    Memberpman908
    I was trying to understand out the same issue as well.

    For 2006, net interest revenue from the lending business was something like 18% of total revenues, so I am surprised to hear that the segment is as much as 37% of the profits.

    Can you take me through the calculation for 2006?

    Thanks

    SubjectI believe it much less
    Entry04/03/2007 02:02 PM
    Memberdanarb860
    I just decided to use the big-picture numbers from the income statement

    Subjectnetwork effects
    Entry04/14/2007 10:25 PM
    Memberdanarb860
    I also think that the network effects that AXP has by having the full loop becomes more valuable as its customer base grows. I am not as not as happy to get card-member growth through the domestic partners as you are. I would rather get it directly. These members aren't as profitable and are dilutive to the full loop.


    Subjectmy own ? on FDC
    Entry04/14/2007 10:30 PM
    Memberdanarb860
    anybody have a view on whether KKR is going to revamp FDC's business strategy?

    Subjectunit economics
    Entry05/19/2007 08:03 AM
    Memberad188
    isnt the key issue here future interchange rates (merchant discount)? -- used to grow at 5-6%yr for V,MC,AX, but now flatter at 1-2%, maybe 3% -- merchants are fighting back, and yes Amex has a better model (closed loop), but if interchnage stays at such paltry growth rates, how will Amex crank out its double digit earning growth? (btw, I share your analysis that this is a cheap stock with high ROE - even higher on the margin, and money can be made here, to 80 or even 100 over say 3 yrs --- but my question is what Amex can do to get the stock to $150+? and to answer that I think you have to dig into the unit economics of theri model versus MC/V) curious what you think

    Subjectdiscount rate
    Entry05/21/2007 06:47 PM
    Memberdanarb860
    first measure I look at each quarter and I mentionned 2-years ago as well as today with emphasis is discount rate. It is in effect the measure of the business' pricing, or measure of pricing power. I think it is bullish for AXP that it is down a lot, that declines have stopped or been eliminated, and a lot of what made V/MC a force for pricing pressure has changed. In many ways, from merchants and legally, V/MC are under at least as much if not more pressure than AXP. It was their pricing pressure that hurt AXP... not that it is going away, but they have their own issues. There was a time that AXP had huge wars with merchants. Those days are gone for at least now.

    Subjectfollow-up
    Entry01/04/2008 02:59 PM
    Memberdanarb860
    wish I had worked this through sooner than this. I was pointed to AER-U CN which is the old Air Canada Miles program.

    AXP announced that is would take add more investments in marketing, Foundation gifts, and litigation expenses and reserves to its rewards program a "significant" portion of the Visa settlement. During this challenging time in the market, it is a good time for American Express to invest in growth. Clearly the marketing expenses (which signicantly inclue rewards) are going up faster than revenue. The Rewards reserve is a fast turning liability. therefore, it concerns me that the amount of any charge here will represent less of a one-time charge and more of an an on-going expense that would be a recurring reduction to earnings over a 1-2 year basis. However, I do not know. I do not know what AXP's metrics are in this part of the business or how big the overall charge will be and how it will be broken down. Sorry. Did want to update though.

    Subjectlending npl
    Entry01/04/2008 11:23 PM
    Memberad188
    In one of AXP's investor presentations they show that NPLs in the lending business peaked around 10% in the last credit induced recession (1990-1991). Given the similarities of the current environment to that period is it out of the question that lending chargeoffs approach that 10% figure (from 2% today)?

    Also, unrelated, can you explain why retained earnings in shareholders equity is so low given the level of actual earnings in the current business? I'm having trouble reconciling why this great franchise hasn't really accumulated that much in net worth?

    Subjectresponses
    Entry01/05/2008 12:29 PM
    Memberdanarb860
    NPL's can go anywhere. Certainly AXP has a higher quality base than others, but who knows. Certainly their network business provides a buffer that many other firms don't have.

    Page 7 of the Annual Report shows Shareholders Equity changes for each year. the answer to your questions is buy-backs.

    Subjectreserves
    Entry01/05/2008 12:51 PM
    Memberdanarb860
    as disclosed in the Annual Report, reserve for rewards was $3.8bn. Also, I think the amount to be recognized for the 3 factors they list will bump up against 1.1bn, not the 2.2bn overall settlement.

    Subjectbig picture
    Entry01/05/2008 03:13 PM
    Memberjsc60
    Any discussion of financials in this enviroment quickly resembles a debate about 3rd world politics: was the candidate killed by a bullet or a bomb? This is not to excuse the ignorance of CEOs or the greed of mortgage brokers. But after the gunsmoke clears, how likely is it that AXP will earn less than $3.00 this year (with the low estimate from 17 analysts at $3.30), or $4.00 normalized over the next three years, i.e., '08-'10 (the low est for 12-08 is $3.55)? Backing out the $0.72 div p.a., the stock now trades at 14.7x and 13.6x low estimates. This is a relative PE of 0.8x. It seems very cheap to me -- like most other financials -- and this is a better franchise. Technically, one can die from leprosy (bad debt exposure), the plague (the consumer quits), and malaria (President Obama taxes unearned income at 100%), but only in third world countries. Then again, may be I'm talking like someone who is long the stock.

    Subjectyou tell me
    Entry01/05/2008 06:32 PM
    Memberdanarb860
    I believe the Visa settlement is one-time income. I think much of the expense, ex litigation and some foundation amortization is recurring. given the reserve situation, recurring earnings are lower than have been reported. I own, owned too soon, regretted writing up and am cautious.

    Subjectwill revist
    Entry01/07/2008 02:56 PM
    Memberdanarb860
    I will revist post the announcement on reserves. Their announcement.
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