American Express Q3 Earnings: Investments Hit Profits, Cardmember Growth Solid
On October 21st, after market hours, American Express (NYSE:AXP) released its earnings for the third quarter ending September 30th [1]. The company reported a year-over-year decline of 14% in net income, though share repurchases limited the decline in EPS to 11%. Major factors that dragged earnings down were changes in the company’s co-branded relationships and an increase in spending on growth initiatives. Industry headwinds continued into this quarter, as low gas prices negatively impacted average transaction sizes (down 3% y-o-y) and a strong U.S. dollar affected international revenues. In this article, we take a closer look at the trends observed during the quarter.
Our price estimate of $94 for American Express’ stock is more than 20% above the current market price. We are in the process of updating our model for the Q3 earnings release.
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See our complete analysis of AmEx’s stock here
Co-Branded Partnerships Are Becoming More Expensive
In Q3, American Express renewed co-branded relationships with many of its partners including Delta, Starwood, Cathay Pacific and British Airways. These renewals led to higher costs as cardmember services/other expenses increased 31% y-o-y and member rewards, which increased 4% y-o-y. The higher costs indicate the fierce competitive environment in the credit card space, as competitors fight for merchants by offering lower transaction fees and better services or rewards on co-branded cards.
Given the loss of Costco and JetBlue Airways [2] as partners earlier this year, AmEx cannot risk losing more merchants, which might drive service/reward costs higher going forward. While the company tried to make up for the loss by signing Sam’s Club, it is unlikely to completely recover the lost Costco volumes. Moreover, in the wake of the DoJ ruling, Amex could be forced to reduce its transaction fee rates to remain competitive. In the last few years, Amex’s transaction fee in the U.S. has come down considerably as shown below.
Investments In Growth Initiatives To Support Long-Term Growth
The termination of the Costco relationship in early 2016 could significantly impact the number of AmEx’s cards in circulation, as Costco co-branded cards account for 10% [3] of the company’s total cards. Considering the extent of the loss, Amex decided to increase spending on cardmember and merchant acquisitions. As a result, marketing and promotion expenses increased significantly in the recently concluded quarter to about $850 million, 8% higher than the prior year and 14% higher when adjusted for currency exchange rates.
While the incremental spending will weigh on the company’s profits in the short-term, the benefits are significant and are already starting to show up. Compared to a quarterly average of 1.4 million card acquisitions in the U.S. in 2014, the company added 2.3 million cards in Q3 2015, 60% higher than last year’s average. [4]
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Sources:
Seeking Alpha Earnings Transcript
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