American Express’s Q3 Results Highlight A Major Shift In Strategy

American Express (NYSE: AXP) reported a better-than-expected performance for the third quarter recently, with strong gains from the improved interest rate environment also prompting the card lender to increase its outlook for full-year 2017. This is some good news from the company, which had posted a string of subpar operating performances since it lost its long-time card co-branding partnership with Costco to rival Citigroup early last year. But what really caught our attention in American Express’s results for Q3 was the sharp jump in loan provisions, combined with a spike in expenses related to cardmember rewards and services. These indicate that the company is looking at sizable charge-offs on card loans made to customers outside its core affluent segment, even as it is forced to dole out higher rewards to keep U.S. banking giants from eating into its base of affluent cardholders. While the strategy of increasing its share of the non-affluent market makes sense in the long run given the fierce competition in the U.S. card industry, this will have a notable negative impact on American Express’s margins in the long run.

We maintain a $88 price estimate for American Express’s stock, which is slightly below the current market price.

See our full analysis for American Express here

The table above summarizes the factors that aided American Express’s pre-tax profit figure for Q3 2017 compared to the figures in Q3 2016 and Q2 2017. Revenues jumped noticeably compared to the period a year ago (which was the first full quarter for which American Express reported results without the Costco card portfolio). The single biggest contributing factor here was the improvement in interest income, which was aided by both steady growth in the company’s card loans and the better interest rate environment, as shown in the table below.

The top line also benefited from the higher number of cards in circulation, as this translated into higher card fees and commissions for the company. However, transaction-related revenues nudged lower compared to the previous quarter as a result of the reduction in U.S. card purchase volumes, from $177.6 billion in Q2 2017 to $176.4 billion in Q3 2017.

As we had pointed out in American Express’s Q2 results as well, the company has substantially increased its cardmember-related costs over recent quarters to provide better rewards and more differentiated services to its affluent target segment. While this has helped the number of cards in circulation grow steadily, the resulting increase in revenues has been at a much slower rate than the increase in associated costs. We capture this trend in the chart below, which shows non-interest expenses for AmEx’s U.S. card operations as a percentage of the division’s revenues. We expect this figure to remain elevated going forward, as the company will continue to face stiff competition from banking giants JPMorgan, Bank of America and Citigroup in the U.S. affluent segment.

Finally, there are two factors behind the sharp increase in loan provisions compared to Q3 2016 as well as Q2 2017. While the industry-wide trend of an increase in card charge-off rates this year is the primarily reason behind the jump, American Express’s push into other customer segments has exaggerated the figure. This is because the company clearly expects higher charge-off rates for card loans outside the affluent segment in the future – something that we highlight in the chart below.

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