American Express (NYSE:AXP) was able to capitalize on strong U.S. holiday season sales, as net income for the fourth quarter of 2013 doubled the amount reported in 2012.  Foreign exchange (FX) adjusted billed business was up 9%, driving a 5% increase in revenues. Lower net write-offs also allowed for a 17% decline in provisions for losses, further adding to the bottom line. The company’s spend-centric model and closed-loop network have allowed it to maintain growth through a tough economic period in the last few years. Improvements in the economy will allow AmEx to further expand in the coming years.
To arrive at a price estimate for the company, we have used a modification of the dividend discount model (DDM). In our model, we are estimating the total income that can be returned to shareholders and discounting this value back to the present. American Express started a capital distribution plan in 1994 and has since returned 66% of capital generated back to shareholders. In the last two years, this percentage was higher; in 2012, the company returned 98% of capital generated while in 2013, the company returned 81% of capital generated. AmEx maintains a long term target of returning 50% of its capital to shareholders, however, on the basis of recent trends, we are forecasting an adjusted common actual & potential dividend payout ratio of 66% through 2020. Our $79 price estimate for the company’s stock is at a discount of about 10% to the current market price.
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Holiday Season Spending Trends
American consumers braved adverse weather conditions and kept up the holiday shopping spirit in 2013; the National Retail Federation reported a 3.9% increase in 2013 holiday retail sales.  American Express, which earns half of its revenues from the U.S., reported a 9% increase in card-member spending which led to an 8% increase in revenues. Total cards-in-force increase from 52 million to 53.1 million.
AmEx generally targets a more affluent customer base, offering rewards and discounts to high spending customers. The average American Express household earns about $97,000 per year.  Payment volume per transaction is around $150 for American Express cards, much higher than the average of $55 for competitors like Visa (NYSE:V), MasterCard (NYSE:MA) and Discover Financial (NYSE:DFS). Data from the U.S. Department of Commerce shows that Americans are more inclined to spend; personal saving as a percentage of disposable personal income has gone down from 6.6% in the fourth quarter of 2012 to 4.9%.  Disposable personal income increased 3% through the third quarter and was part of the reason for the spending trends through the fourth quarter.
Turning to growth prospects: according to the 2010 U.S. census, around 22% of the households in the U.S. earn more than $95,000 per year.  These households form the primary customer base for American Express, and the company has achieved a penetration of nearly 50%. The improving job market, which saw the unemployment rate drop below 7% in December, should allow AmEx to further increase the number of cards-in-force in the coming years. 
Third Party Growth
Outside the U.S., American Express is using a third-party model to expand its card-member and merchant base at cost levels that would not have been feasible on its own. Through the Global Network & Merchant Services (GNS) division, AmEx invites established financial institutions to issue cards carrying the signature American Express logo and also to act as merchant acquirers. This division accounts for 15% of the company’s revenues but is a fast growing segment; transaction fees earned through third party issuers have increased by a compound annual growth rate of ~15% in the last four years, higher than the CAGR of ~9% for AmEx-issued cards in the U.S.
In the December quarter, American Express signed more GNS agreements to achieve growth. The total cards-in-force increased 8% over the last year to 40.7 million; in contrast, the number of international propriety cards-in-force is just 15.7 million. GNS card-billed business increased 12% during the fourth quarter (16% on an FX-adjusted basis) with high contributions from Japan and China. We expect further growth from the company in this segment.Notes:
- American Express’ Management Discusses Q4 2013 Results – Earnings Call Transcript [↩]
- Holiday Retail Sales Come in at NRF Expectations, Press Release, January 14, 2014 [↩]
- Spending by affluent helps Amex to strong quarter, Yahoo News, April 18th, 2012 [↩]
- Table 2.1. Personal Income and Its Disposition (A) (Q) [↩]
- Annual Social and Economic (ASEC) Supplement, United States Census Bureau [↩]
- U.S. Department of Labor, Labor Force Statistics from the Current Population Survey [↩]