American Express (NYSE:AXP) has delivered strong bottom- and top-line growth in the last few years, remaining relatively unscathed by the financial downturn of 2008. Revenues have grown at a CAGR of 7% for the last four years while net income has grown at a CAGR of 20%. Unlike Visa (NYSE:V) and MasterCard (NYSE:MA), American Express primarily issues its own cards through its banking subsidiaries, Centurion Bank and AEBFSB, and operates a closed loop model where it acts as the issuer as well as the acquirer bank for most transactions. In this article, we take a closer look at the efficiency of the company’s business model.
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Our $63 price estimate for the company’s stock is in-line with the current market price.
Visa has around 2.1 billion cards in circulation around the world while MasterCard has over a billion cards. In contrast, American Express has only 86 million cards in circulation worldwide of which only 49 million are propriety cards. Clearly, AmEx is not in a position to compete with the incumbents for market share in terms of cards. However, by eliminating the middle man (banks in this case) with its closed loop network, American Express is able to earn more revenue per card. The difference is quite significant – Visa earns about $6 per card in use while American Express earns more than $350 in revenue per card.
Why Is There Such A Big Difference?
American Express primarily earns revenues from merchants accepting its cards. On average, the company charges a discount rate of 2.52% from merchants while the industry average is around 2%. American Express is able to charge a higher rate from merchants as it promises to bring them higher spending customers. The annual average spend per AmEx card is around $15,000 while the spend per Visa card is less than $2,000 per year. Targeting the affluent section of society has been the key for American Express; the average American Express household earns about $97,000 per year .
The transaction volume on American Express issued cards was $890 billion in 2012, out of which $470 billion came from the U.S. AmEx earned a net transaction fee of 1.89% from these transactions, leading to revenues of $8.9 billion in transaction fees from the country.
There are around 31 million propriety American Express cards in the U.S. The 2010 U.S. census revealed that around 26 million or 22% of the households in the country have an annual income over $95,000.  These households form the target customer base for American Express. Assuming, on average, around two adults per household, we get a potential customer base of 52 million. The penetration achieved by American Express is around 60%.
The average population growth rate for the U.S. is around 0.7%.  Assuming this growth rate for our forecast period and keeping the percentage of households earning above $95,000 at 20%, we arrive at a potential customer base of 65 million for American Express by the end of our forecast period. We expect AmEx to maintain its 60% penetration, leading to a total of 39 million American Express branded cards in the U.S.
Should American Express be able to increase penetration to above 70%, it could reach a total of 47 million cards in use in the U.S. Our model shows an upside of 10% to the stock price estimate if this is realized. On the other hand, considering that the U.S. economy’s recovery from the financial downturn of 2008 has been rather sluggish, there is a possibility that the average income per household might actually drop in the coming years. If only 15% of the households make enough money to qualify as American Express customers by the end of our forecast period and the company maintains a penetration of 60%, there would be only 30 million cards in circulation. This means 10% downside to our price estimate. You can modify the interactive chart below to gauge the effect a change in the number of American Express cards in the U.S. would have on our price estimate.
This analysis does not consider the recently launched Bluebird prepaid card that targets Wal-Mart (NYSE:WMT) customers. The card is a step away from the spend-centric model currently used by American Express. More than 5o% of Wal-Marts’ customers make less than $50,000 a year and are not what are typically considered American Express customers. 
Please read our article: What Does Partnering With Wal-Mart Mean For American Express? for more on our stance. The third-party issued American Express cards are also not considered in this analysis, please read our article: Why American Express Is Growing Its Third Party Issued Cards Business to know more.