American Express Earnings Will Show U.S. Spending Recovery Intact

American Express (NYSE:AXP) will announce its earnings for the second quarter of 2012 on Wednesday. The company’s adaptation of the spend-centric model with its focus on the spend potential of higher income groups has helped it perform strongly and wade through tough market conditions. Amex reported a net income of $1.3 billion in the first quarter of 2012, and will look to build on the 7% year-on year growth observed in the same. We look below at a few key trends that might influence the company’s performance.

See our complete analysis of AmEx’s stock here

Consumer Spending On A High

Despite the uncertainty surrounding the U.S. economy, consumer spending has seen a lift in the last few months. The Federal Reserve reported an increase of $8 billion in credit card debt in May, the highest increase in the statistic since 2007, indicating a rise in confidence the American populace. ^[1] Total consumer borrowing increased by $17 billion during the same period to bring the seasonally adjusted total borrowing to a four-year high of $2.57 billion.

Although encouraging, these numbers should be read with a note of caution, particularly with the unstable state of the economy. A recent survey by American Express’s competitors, Discover Financial (NYSE:DFS) indicated that more than half (53%) of the company’s consumers in the U.S. expect their spending in the next few months to decline as they maintain a cautious view of the country’s economy.  ^[2] (See Discover Financial Charged For $38 With Diverse Offerings)

We maintain a conservative forecast for spend on Amex-issued cards, with steady growth driven by factors such as mobile payments (discussed below). You can gauge the effect of a change in the forecast on our price estimate by modifying the interactive chart below.

Mobile Payments To Push Business

American Express has taken several initiatives such as a collaboration with mobile wallet service, Isis, to capitalize on the surge in mobile phone payments. An increasing number of smartphones manufactured now utilize near-field communication (NFC) chips, which facilitate mobile payments. Mobile payments account for 5% of retail store sales in the U.S., with the number expected to rise to 19%, by 2016. ^[3]

A recent survey by Deloitte revealed that smartphone shoppers are 14% more likely to make a purchase than non-smartphone users. This is good news for American Express, which saw a 10% increase in billings in April and May. We forecast cardmember spend on Amex-issued cards to increase through the next few years, as mobile payments gain acceptance throughout the world.

A Slice Of the Debit Pie

The Durbin amendment to the Dodd-Frank bill, which came into effect last October might provide American Express a doorway to Debit card market, currently dominated by  MasterCard (NYSE:MA) and Visa (NYSE:V). The bill requires banks with more than $10 billion in assets to use separate payment processing networks for signature authorized and PIN authorized debit card transactions. ^[4] This regulation is basically aimed at breaking the duopoly enjoyed by the aforementioned companies, as banks will have to migrate processing operations to other service providers such as American Express.

Debit cards are a lucrative alternative to their credit counterparts, as they all customers to spend money from their own pockets without the burden of carrying cumbersome cash, debit payments account for more than 35% of all non-cash payments in the U.S. ^[5] American Express has recently announced plans to set up Europay Mastercard Visa (EMV) compliant processors throughout the U.S. to capitalize on this trend. These processors will facilitate processing of diverse payments methods including PIN, signature, contactless and mobile transactions. (See American Express Headed For $60 With Plans To Adopt EMV Technology) Despite the reduction in interchange fees which discourages banks from issuing the cards, the popularity of debit and pre-paid debit cards is expected to rise through the next few years. Despite the reduction in interchange fees which discourages banks from issuing the cards, the popularity of debit and pre-paid debit cards is expected to rise through the next few years.

The closed-loop network adopted by American Express allows the company to analyze market trends and come up with suitable marketing strategies and schemes. Amex reported industry low delinquency rates 1.2%, last month, and we expect its yields from credit card loans, which account for 11% of our price estimate to remain steady through our forecast period.

We currently estimate a price of $60, concurrent with the current market price.

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1. Consumer borrowing up $17.1 billion in May, USA Today, 9^th July, 2012 [↩]
2. Consumer Confidence Declines in June, According to the Discover U.S. Spending Monitor, Press Release, Enhanced Online News, 3^rd July, 2012 [↩]
3. Smartphones will influence 19pc of retailers’ sales by 2016: study, Mobile Commerce Daily, June 28^th, 2012 [↩]
4. The Durbin Amendment Explained [↩]
5. The 2010 Federal Reserve Payments Study [↩]