American Express Manages Expenses To Offset Slowdown In Revenue Growth

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AXP: American Express Company logo
AXP
American Express Company

American Express (NYSE:AXP) reported a 12% increase in net income for the first quarter of 2014, with revenues up 4% and operating expenses falling 4% from the prior year. [1]  Foreign exchange (FX) adjusted billed business was up 7%, driving a 5% increase in adjusted revenues. This growth rate was down slightly from the 9% level reported during the December quarter. In the U.S., the billed business growth rate fell from 9% in the fourth quarter of 2013 to 7%, affected by a decline in small business and spending from corporate card members. Outside the U.S., billed business increased 10% on an FX adjusted basis with the EMEA growth rate increasing from 6% in the December quarter to 7% in the March quarter.

American Express issues its own cards through its banking subsidiaries, American Express Centurion Bank and American Express Bank, FSB, and employs a closed-loop network.  The company’s primary source of revenues is the discount fee charged to merchants who accept its cards. These fees are charged as a percentage of the charge amount processed for the merchant and account for 65% of the company’s revenues. Unlike Visa (NYSE:V) and MasterCard(NYSE:MA), American Express’ revenue model does not depend on the volume of transactions processed, but rather on the total amount spent by the customer. During the first quarter, the company’s total cards-in-force increased from 107.2 million at the end of 2013 to 108.2 million. The average basic cardmember spending increased 2% over the first quarter of 2013.

Our $79 price estimate for the company’s stock implies a discount of 10% to the current market price.

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Growth In U.S. Business Continues

American Express’ U.S. card services division accounts for more than half of the company’s revenues. AmEx reported a 6% increase in revenues from the division for the first quarter, with total cards-in-force increasing 4% to 44.1 million and average basic cardmember spending up 3% over the prior year. This led to a 5% increase in discount revenues. American Express primarily targets affluent customers who are likely to spend more; the average payment volume per transaction for AmEx cards is around $150, while that for Visa is $50. This strategy has allowed the company to maintain growth despite economic uncertainty in the country, and we expect a further increase in cardmember spending as the economy continues to improve.

Third-Party Growth Outside The U.S.

For its international business, AmEx reported a 1% increase in total proprietary cards-in-force, with average basic cardmember spending dropping 1%. However, the company observed growth in its Global Network & Merchant Services (GNS) division, which invites established financial institutions to issue cards carrying the signature American Express logo and also to act as merchant acquirers. AmEx has been using this third-party model to expand its global cardmember and merchant base at cost levels that would not have been feasible on its own. For the March quarter, total GNS cards-in-force increased 8% to 41.3 million while card billed business grew 10% (15% on an FX adjusted basis). Growth was particularly strong in China and Japan, but the strengthening of the U.S. dollar against the Japanese Yen offset growth. We expect further growth from the company in this segment, but currency fluctuations might hamper prospects.

Credit Risk

AmEx also earns interest on loans issued to cardholders and is thus exposed to credit risk. High earning customers in the country are more likely to pay off their credit card debt in time and American Express has been able to maintain delinquency rates and charge-off rates lower than the industry average. The delinquency rate has been around 1.1% to 1.2% for the last four quarters while the charge off rate is around 1.7%. In contrast, the delinquency rate for credit card loans for all commercial banks in the U.S. is around 2.39%. [2]

The company reported a 3% increase in loan balance for the first quarter of 2014 with U.S. loans up 4%. However, stable delinquency rates and growth in the loan portfolio led to a smaller reserve release which resulted in a 17% increase in provision for losses. Going forward, AmEx expects an increase in the historically low charge-off and delinquency rates and will have to manage provision for losses.

Managing Expenses

Total operating expenses fell 4% during the three months ending March, allowing the company to report strong bottom line growth. Salaries and employee benefits fell 5% from the prior year while expenses on professional services were down 3%. However, American Express does not expect to maintain similar declines throughout the year.

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Notes:
  1. American Express Reports First Quarter EPS of $1.33, Up 16 Percent from a Year Ago; Revenues, Loans and Card Member Spending Increase; Operating Expenses Decline from Year-Ago Levels, Investor Relations []
  2. Delinquency Rate On Credit Card Loans, All Commercial Banks, Board of Governors of the Federal Reserve System []