I wrote up American Express roughly 2 years ago. The company has long since completed its spin-off of Ameriprise, and I believe continues to be a fantastic investment. The stock has done well since the spin-off; but it is recently down 10% to a level which I think provides a nice short-term entry opportunity.
In 2006, the company earned just over $3.00. Earnings are expecting to be roughly $3.40 in 2007 and $3.80 in 2008. So the stock is trading at 16.6x this years earnings but under 15x next year. This multiple seems to be too low for a company with solid double--digit earnings growth and ROE of nearly 35%. The ROE exceeds the 33% that was forecasted previous to the spin-off.
The company has a lending portfolio that is roughly $50bn. But this compares with an equity market-capitalization of about $67bn. In this respect, thinking about American Express as a traditional credit-card issuer is not appropriate. In fact, the company could easily take on more debt if it wanted to do major buy-backs (more on buy-backs below). An interesting company to look at as a comparison is MasterCard, which just came public. With ROE of in the mid-twenties, Mastercard is showing closer to 20% EPS growth. I think however, that much of this growth is coming from plucking low-hanging fruit as I suspect that the company, formerly coop owned by a number of major banks, may now be profit-focused for the first-time in the after-math of coming public. In this respect, it is worth noting that 2006 transaction growth for MasterCard was slightly below American Express’s.
Compared to any other player, American Express has what I believe to be a dominant position because it controls all aspects of a payment. It touches the paying customer; it is the card issuer; it has the relationship with the vendor; and it processes the transaction. Nobody touches this many pieces of the transactions. All companies operating with any critical mass in the space have relatively high ROE’s. In AXP’s case, touching all pieces creates an efficiency that leads to highly favorable returns. Additionally, the efficiency of the network, combined with the brand as well as the network effects from touching all pieces of the transaction allows AXP to charge a discount rate that is over 1% higher on average than MasterCard and Visa. In fact in 2006, the discount rate at 2.55% was unchanged from 2005. That it is not going down is quite bullish for the company.
Also in 2006 vs. 2005, card billed business was up 13%. Cards in force increased from 43mm to 48.1mm in the US and from 28mm to 29.9mm abroad. Basic cards in force increased from 56mm to 62.5mm. Observers of the company tend to see the key metrics as the discount rate, card billed business, and basic cards in force. Each of these three showed nice growth during the year, and this growth reflects a business that I believe is extremely strong. It isn’t a perfect proxy but comparing marketing, promotion, rewards, and cardmember services to Discount Revenue and Net card fees provides a useful indicator of the business’s health over time. It isn’t a perfect proxy as if the company is investing in the business to show growth, margins can decline and the business can throw off additional cash if the company under-invests. In 2005, these two categories grew a combined 10.72% while the cost categories grew 11.55%. While I do not like this gap and intend to track it carefully going forward, I will point out that discount revenue was up 13% while net card fees were down 2%. I believe this trend reflects that more of the membership growth is coming from partners as opposed to coming directly. Most important to note however, as the leverage is in the card-spend is that card spend is up quite a bit more than the cost categories.
In short, AXP continues in my view to be a superb company. It has tremendous franchise value and it continues to trade at what I view the multiple of an average company. As I mentioned two years ago, the business feels like a fantastic inflation hedge; if prices go up, its earnings power will go up. There are fewer and fewer companies that I believe this can still be said about. So I see both appreciation from earnings growth and revaluation as likely. 18x next year’s projected $3.80 leads to a $68 stock. The $.60 annual dividend yield isn’t going to add much to the returns.
AXP is underlevered. It has $11bn of equity against $66bn equity market cap and $50bn of loans. It has 58bn of long-term and short-term debt. Consequently, there is ample room to put leverage on this company. And compared to two years ago, given the size of the deals in the private equity and banking sectors, it is hard to believe that I am going to write these words, but AXP is buyable.
Continued high ROE, powerful franchise leading to earnings growth, possible expansion of multiple, buybacks