An Overview Of American Express’ Business And Our $62 Estimate

American Express (NYSE:AXP) is one of the few financial companies which pulled through the 2008 crisis relatively unscathed. The company achieved near double digit growth in revenues in the last few years, ending 2011 with revenues of $30 billion and a net income of nearly $5 billion. Amex has built a strong brand name for itself, offering high quality customer service. The American Express card is primarily owned by the high income users as the average American Express household earns about $97,000 per year.

The company has significantly fewer cards in use than its payment processing competitors, Visa (NYSE:V) and MasterCard (NYSE:MA), but still accounted for a quarter of the $2.05 trillion credit card spending in the U.S. last year. ^[1] The average spend per Amex card in the U.S. is more than $10,000, whereas the annual amount charged to a Visa card is close to $1,000.

Given the company’s strong performance in an environment which has proved difficult for most companies and the growth prospects in an ever expanding global economy, we believe that the company has a lot to offer in the coming years. Our $62 price estimate for the company’s stock implies a premium of 10% to the current market price.

See our complete analysis of AmEx’s stock here

Business Model

The revenue earning streams for American Express are:

Transaction Fees collected from merchants accepting American Express cards account for almost two-thirds (63%) of the company’s total revenues. American Express issues its own cards through its bank subsidiaries, American Express Centurion Bank and American Express Bank, FSB (AEBFSB) and thus collects discount fees from merchants. For Visa and MasterCard, this fee is collected by banks which backstop card user defaults. Amex leverages the fact that its customers are affluent and more likely to spend by charging high discount fees from its merchants. The average discount rate charged by American Express is 2.5% of the transaction amount involved, whereas banks issuing Visa and MasterCard generally charge less than 2%.

At the end of 2011, Amex had about 20 million cards in-force in the U.S. and about 10 million outside the U.S. In the first nine months of 2012, the company reported growth of 3% and 9% in cards in the U.S. and outside the country respectively. The average spend per card in the U.S. ($14,000) is slightly higher than outside ($12,000), but this will even out as the global economy grows.

We currently forecast a steady increase in cards-in-force both in and outside the U.S. You can modify the interactive chart below to gauge the effect a change in forecast would have on our price estimate.

Interest Income from customer loans accounts for 15% of American Express’ revenues. Unlike Visa and MasterCard, American Express does not issue credit cards, rather it offers charge cards. What’s the difference? Basically charge card users are obliged to pay the full debt on the card to the issuer at the end of a monthly cycle, whereas credit card users can get away by paying just a portion of their total debt. ^[2] With this model and the fact that it is targeting affluent customers, American Express has been able to maintain low delinquency (around 1%) and charge-off rates through the last few years.

The average loan balance on Amex cards in the U.S. is around $50 billion from which the company earns a yield of around 9%, while the loan balance outside the U.S. is around $9 billion with a yield of 10%. Average loans increased by 4%, year-on-year in the first nine months of the current year. We expect an annual growth rate of around 5% in average loan balance in the U.S.

Annual Membership Fees account for 7% of the company’s revenues. The company charges around $45 per card per annum from its card holders as membership fees.

Travel Service revenues account for another 7% of the net revenues. American Express provides luxury travel services with air travel, car rentals and hotel reservations packaged together. It charges a commission of around 8% on these services. The total travel sales by the company are around $25 billion, with a majority $20 billion to corporate clients.

Other revenues such as royalties and signing fees from Global Network Services (GNS) and insurance premiums from card holder travel account for the remaining 7% of American Express’ revenues.

The major expenses for American Express are on marketing and promotion (33% of revenues) and salaries and employee benefits (40%) of revenues. Apart from this, the company also has to maintain adequate assets to cover for potential loan losses, roughly around 0.33% of the transaction volume on cards in the U.S. and 0.17% of the transaction volume outside the U.S.

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1. AmEx Profit Meets Estimates as Card-Spending Growth Slows, Bloomberg Businessweek, 18^th October, 2012 [↩]
2. American Express Sans Chenault Is Still Attractive , Seeking Alpha, 24^th December, 2012 [↩]