American Express’ Headwinds Likely To Continue In The Near Term

by Trefis Team
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AXP
American Express Company
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American Express (NYSE: AXP) reported a lukewarm performance for the second quarter of the year late last week, with the card lender churning out an earnings beat despite falling marginally short of revenue expectations. Notably, the company’s shares fell sharply after the results were announced – primarily because of the sizable increase in operating expenses as well as card loan charge-offs. We have summarized American Express’s Q2 2018 earnings and also detailed our expectations for the rest of the year in our interactive dashboard for the company, the key parts of which are captured below.

The stock sell-off was unwarranted in our view, as both of the aforementioned trends were expected in Q1 and Q2, and will continue to weigh on the company’s bottom line over the next few quarters. This is because American Express’s new growth strategy seeks to attract more merchants and more card users by slashing transaction fees and by offering larger rewards, respectively. Also, as the card lender adopts a business model that is similar to that of other players in the cards industry and prioritizes credit cards over charge cards (which do not allow the cardholder to carry forward balances beyond a year), charge-off rates are bound to increase before stabilizing.

AmEx’s new strategy is already yielding results, with card loans and payment volumes growing at a faster rate than what it has seen over the years – helping its quarterly revenues soar past the $10-billion mark for the first time in Q2 2018. We believe that the elevated operating expenses in the near future will be largely offset by the sizable value the new strategy will unlock in the long run in terms of enhanced market share. As a result, we increased our price estimate for American Express’s stock upwards from $105 to $110. The current target is roughly 10% ahead of the current market price.

See our full analysis for American Express here

American Express’ New Strategy Has Led To Growth In Card Loans, Payment Volumes

With its decision to reduce merchant fees, American Express stands to gain more ground across cardholder segments, as increased acceptance among merchants should boost the number of people applying for AmEx cards. The impact of this on the lender’s card portfolio is already visible, with the total card portfolio crossing $75 billion for the first time. As was seen in Q1 too, growth in American Express’ card portfolio outpaced growth in its charge card receivables, as the lender is now more focused on the former. It should be noted that a higher card portfolio coupled with the improving interest rate environment should translate into higher net interest income for AmEx going forward.

At the same time, as a larger number of cardholders use their cards for making payments, there should be a proportional increase in total card balances. This can be seen in the chart below, as total purchase volumes (card billed business) rose to a record high of nearly $300 billion in Q2. Notably, billings on AmEx’s proprietary network crossed $250 billion for the first time this quarter.

However, These Efforts Have Raised Card Charge-Off Rates

American Express reported an increase in its total card charge-off rate to 2.1% from levels that generally remained around 1.7% over 2016-17. This in turn resulted in an increase in card provisions for the quarter – weighing on the bottom line. While the current charge-off rate is the highest since early 2012, this trend was largely expected given the company’s renewed push into card lending.

In any case, it should be noted that American Express has enjoyed the lowest card charge-off rate among U.S. card lenders over the years because of its focus on the affluent segment, and its charge-off rates are still well below that of its peers. To put things in perspective, the average card charge-off rate across U.S. card lenders was around 3.5% in 2017. Accordingly, we do not view the increased card charge-off rate as a cause for concern.

We expect American Express to report EPS of $7.33 for full-year 2018. Taken together with an estimated P/E ratio of 15, this works out to a price estimate of $110 for Amex’s shares, which is about 10% ahead of the current market price.

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